sMf■Vli'^TPIAll 


J  T  LINE 


:;LiNTON    COLLVER 


STMFNI'  RANKERS  ASSOCIATION 

Oi-  /VJ4BR1CA         iiiiliiiiiiiijlii 


THE  LIBRARY 

OF 

THE  UNIVERSITY 

OF  CALIFORNIA 

LOS  ANGELES 

GIFT  OF 


Gift  U,C.  Ubrary 


INDUSTRIAL 
SECURITIES 


INDUSTRIAL 
SECURITIES 


BY 

CLINTON  COLLVER 


UBRARY  OF 

Hcr€iB&  Trusi  Cosipany  of  Cafiforaia 


New  York 
Doubleday,  Page  &  Company 

for 

Investment  Bankers'  Association 

of  America 

1921 


3  51.1  C  45 


Copyright,  1921,  by 
Investment  Bankers'  Association  of  America 

JU  rights  reserved,  including  that  of 

translation  into  foreign  languages, 

including  the  Scandinavian 


S\>'L. 


INVESTMENT  BANKERS'  ASSOCIATION        (I  ^5 
OF  AMERICA 

Education  Committee 

Lawrence  Chamberlain 
E.  W.  Bulkley 


Neither  the  Investment  Bankers' 
Association  of  America  nor  its 
Education  Committee  assumes 
responsibility  for  any  statements 
made  in  this  book  or  in  any  books 
referred  to  in  this  book.  The 
booksreferred  to  were  selected  with 
regard  to  their  general  availability 
and  without  prejudice  to  any  other 
books  treating  of  the  same  subj  ects. 


c:>*!io«-^y5  ,« 


PREFACE 

Recognition  that  ours  is  a  highly  developed 
industrial  nation  has  been  belated.  Only  in 
the  past  few  years  have  industrial  securities 
received  favor  as  investments. 

Owing  to  these  facts  and  to  the  lack  of  ac- 
cepted standards  of  industrial  accounting,  very 
little  pubHshed  material  is  available  in  regard 
to  the  analysis  of  industrial  securities  aside  from 
a  book  which  is  referred  to  many  times  in  the 
following  pages.  However,  since  it  follows  that 
a  company  which  deserves  good  credit  should 
have  securities  worthy  of  consideration,  texts 
on  credit  contain  helpful  information,  as  well  as 
texts  on  accounting. 

The  student  who  approaches  the  subject  of 
industrial  security  analysis  after  obtaining  a 
good  working  knowledge  of  accounting  is  at  a 
decided  advantage,  although  the  material  pre- 
sented herewith  has  been  set  forth  in  a 
simple  form  easily  to  be  grasped  by  any  one 
who  has  a  general  knowledge  of  business  and 
finance. 

Special  effort  has  been  made  to  treat  at  some 
length    reserves,   funds,   surplus,    book   value, 

[vii] 


and  other  such  subjects  which  have  been  less 
generally  understood  than  others. 


It  is  presumed  that  the  reader  has  covered 
the  field  indicated  by  the  "Courses  of  Study 
in  Corporation  Finance  and  Investment"  pre- 
pared by  Hastings  Lyon  and  published  by  the 
Education  Committee  of  the  Investment  Bank- 
ers' Association,  obtainable  from  the  Secretary 
of  the  Association,  iii  W.  Monroe  Street, 
Chicago.  Suggestions  as  to  the  use  of  the  fol- 
lowing pages  will  be  found  in  the  introduction 
of  the  outline  in  Corporation  Finance  and  In- 
vestment, 

Cross  references  will  be  found  in  the  following 
chapters  e.g.,  "See  also  XV,  Page  91."  Such  a 
citation  refers  to  a  chapter  and  page  of  the  fol- 
lowing and  is  particularly  used  to  help  the 
reader  who  is  looking  up  a  special  phase  of 
industrial  securities. 

While  some  material  following  has  not  been 
published  before,  by  far  the  most  of  it  consists 
of  digests  and  references  accompanied  by  cita- 
tions. For  convenience  the  name  of  the  author 
and  pages  only  are  given  usually.  A  complete 
bibliography  with  names  of  authors  in  alphabet- 
ical order  will  be  found  on  pages  101-103.  Some 
four  authors  have  written  more  than  one  book 
which  has  been  found  useful.  The  citation  will 
show  which  book  is  referred  to— for  example: 
Tovey — Prospectuses,  or  Tovey — Balance  Sheets. 

Citations  from  the  Annals  of  the  American 

1  viii  ] 


Academy  of  Political  and  Social  Science,  Mch., 
1920,  number,  are  referred  to:  Annals — Moody 
Reed,  or  Lyon,  showing  the  author  of  the  chap- 
ter referred  to. 

On  pages  104-105  immediately  following  the 
bibUography  will  be  found  suggestions  as  to 
sources  of  information  in  regard  to  specific  cor- 
porations. 


[Ix] 


CONTENTS 

PAGE 

I.    Introduction 3 

1.  Varieties  of  Industrials — Magnitude  .      .  3, 

2.  Industrials  Compared  with  Railroads      .  3 

3.  Advantages  of  Large-Scale  Enterprise     .  4 

4.  Development  of  Large  Industrial  Enter- 

prises and  Market  for  Their  Securities  4 

5.  Limitations  of  Large-Scale  Enterprise     .  5 

6 

6 
6 

7 
8 

24 
24 


II.    Classes  of  Industrial  Securities 

I.     Distinctions  Between  Stocks  and  Bonds 


2.  Kinds  of  Stocks. 

3.  Kinds  of  Bonds  and  Notes 

III.  Provisions  of  Preferred  Stocks 

IV.  Industrial  Mortgages   . 
I.     Analysis  of  the  Indenture 


2.     Rights  and  Duties  of  Corporate  Trustees  24 

V.    Background    of    Industrial    Corporation 

Prosperity 25 

I.     General  Business  Factors 25 

(A)  Integration  and  Sources  of  Supplies  25 

(B)  Location 25 

(C)  Standardization 26 

(D)  Fluctuation  in  Demand      ...  26 

(E)  Diversification 27 

(F)  Competition 27 

xi 


2.     Factors  of  Management 27 

(A)  Personal  P^quation    .....  27 

(B)  Financial  Control— Underwriters- 
Directors — and  Standing  of  Stock- 
holders       28 

(C)  Contracts  and  Alliances      ...  29 

(D)  Financial  Policy       .....  30 

(E)  Loyalty  and  Cooperation   ...  32 

(F)  Good  Business  Methods     ...  32 

VI.    Policy  of  Publicity 33 

VII.    Accounts — General     .......  35 

1.  Lack  of  Uniformity  in  Accounting  and 

Published  Reports.     Illustrative  Bal- 
ance Sheets 35 

2.  Certificates  of  Public  Accountants  .      .  40 

VIII.    Analysis  of  Balance-Sheet  Items— Debit  42 

1.  Capital  Assets 42 

2.  Permanent  Investments 43 

3.  Treasury  Stocks  and  Bonds  ....  44 

4.  Good  Will 44 

5.  Patents,  Trademarks,  and  Brands   .      .  45 

6.  Working  and  Trading  Assets      ...  46 

7.  Current  Assets -47 

8.  Sinking,  Insurance,  and  Other  Special 

Funds 4S 

9.  Deferred  Assets 49 

IX.    Analysis  of  Balance-Sheet  Items— Credit  50 

1.  Bonds    .......■■■  SO 

(A)  General  Consideration      ...  50 

(B)  Bond  Provisions 5' 

(C)  Convertible  Bonds      ....  53 

2.  Short-Term  Notes 54 

3.  Preferred  Stocks 55 

4.  Common  Stocks 5° 

(A)  Seldom  to  be  Considered  Invest- 
ment Securities 5^ 

(B)  Changing    Capitalization    Form 
Rights 57 

xii 


XI. 


XIL 


XIII. 


XIV. 


XV. 


5- 
6. 

7. 

8. 


Current  Liabilities 59 

Working  Capital 60 

Reserves 62 

Surplus 63 


X.    Book  Value 66 


Comparisons  of  Balance  Sheets — Differ- 
ent Years 70 


Income  Accounts     

1.  Consistent  Form  Necessary  . 

2.  Holding  Company  Figures 

3.  "Standard"  Corporation  Form 


Analysis  of  Income  Accounts 

Gross  Sales       .... 
Gross  and  Net  Profit. 
Other  Income  .... 
Total  or  Gross  Income 

Interest       

Profit  and  Loss  Surplus   . 
Margin  of  Safety  . 
Average  Profits 


Form  and  Amount  of  Capitalization  . 

1.  Relation  to  Physical  Value      .    . 

2.  Relation  to  Earnings  and  Gross  Sales 

Special  Financial  Standards  .     .     .     , 
Two-for-One  Rule 


Supplementary  Ratios: 

(A)  Comparison  year  to  year: 
Receivables  to  Merchandise 

(B)  Net  Sales  to  Receivables 

(C)  Sales  to  Merchandise 

(D)  Net  Worth  to  Fixed  Assets 

(E)  Sales  to  Net  Worth  .      .      . 

(F)  Total  Debt  to  Net  Worth   . 

(G)  Sales  to  Fixed  Assets     . 

xiii 


73 
73 
75 
75 

77 

77 
78 
80 
81 
82 

83 
84 

85 

86 
86 
86 

89 
89 


89 
90 
90 
90 
90 
90 
90 


Other  Financial  Standards: 

(A)  Working  to  Total  Capital 

(B)  Cash  and  Cash  Resources 

(C)  Turnover 

(D)  Operating  Ratio     , 


XVI.    New  Promotions 

1.  General  Considerations  . 

2.  Special  Information  Tests 

XVII.    Receiverships  and  Reorganizations 


91 

91 
92 

92 
93 

95 
95 
97 

99 


Complete  Bibliography loi 

Principal  Sources  of  Information  in  Re- 
gard TO  Individual  Industrial  Corpora- 
tions   104 

Index 106 


^ 


XIV 


INDUSTRIAL 
SECURITIES 


Introduction 

Varieties  of  Industrials — Magnitude. 
Collver^  I3~IS- 

Subdivisions  of  manufacturing. 
Subdivisions  of  distributing  and  trading. 
Construction. 

Mining  not  considered  except  in  cases  in 
which  mining  operations  are  only  a  part  of 
an  integrated  business. 

Industrials  Compared  with  Railroads. 
Annals — Moody ^  76;  Collver^  9-1 1. 

Stability  of  earnings. 

Elasticity  of  capital — possibility  of  expansion 
through  diversification  of  products  and  ex- 
pansion of  markets. 

Permanency  of  demand. 

Standardization  of  activities  and  methods. 

Difference  in  business  and  financial  structure 
and  financial  methods. 

[3I 


3.  Advantages  of  Large-Scale  Enterprise. 

Collver^  17-20. 

Ease  of  financing. 

Ability  of  securing  best  technicians  and  execu- 
tives, yet  not  dependent  upon  any  one. 

Advantage  in  advertising. 

Location. 

Improved,  economical,  and   standard   meth- 
ods. 
Experimental  and  development  work. 
Purchasing  or  producing  raw  products. 
Selling — including  exporting. 
By-products. 
Strikes,  accidents,  etc. 
Average  demand. 

4.  Development  of  Large-Scale    Industrial  En- 

terprises and  Market  for  Their  Securities. 

Large-scale  enterprise  result  of  improve- 
ment in  transportation  and  communication. 
Collver,  17. 

Methods  of  eliminating  destructive  compe- 
tition: agreements,  business  trusts,  associa- 
tions, pools,  combination  trusts,  community 
of  interest  organizations,  complete  consolida- 
tion and  holding  companies.  Amalgama- 
tions and  mergers.     Effect  of  competition. 

Ilaney,  100-255;  Mead,  348-374;  Dew- 
ing, 518-529.  For  collateral  reading  see 
Dezving,  529-546. 

[4I 


Ripley,  Introduction.  For  collateral  read- 
ing the  entire  text  is  interesting. 

Influence  of  speculative  possibilities.  De- 
velopment of  a  market  for  conservative  in- 
dustrial securities. 

Annals — Moody,  73-75. 

Limitations  of  Large-Scale  Enterprise. 

Through  too  rapid  and  easy  enlargement 
of  capitalization,  a  business  may  be  ex- 
panded dangerously,  either  because  of  sub- 
sequent unfavorable  general  conditions  or 
because  those  in  control  are  not  big  enough 
calibre  to  make  a  really  large  enterprise  profit- 
able. 

A  large  enterprise  is  sometimes  a  shining 
mark  for  ignorant  or  self-seeking  political 
prosecution. 

Decreased  responsibility  sometimes  felt 
by  subsidiary  officials — organization  may  be 
so  large  as  to  resemble  political  government, 
making  applicable  part  of  the  arguments 
against  municipal  ownership. 

Decreased  responsibility  sometimes  felt 
toward  the  stockholders. 

Increased  possibilities  of  manipulation  and 
fraud. 

Haney,  234-237;  Dewing,  558-566. 

See  also  V.  2A.     Pages  27-28. 


[S] 


II 

Classes  of  Industrial  Securities 

1.  Distinctions  between  Stocks  and  Bonds. 

Chamberlin,  29-37.     4^8. 

2.  Kinds  of  Stocks. 

Different  kinds  of  Stocks — common  and 
preferred — their  rights  and  special  features. 

The  "Stock  Exchange  Business,"  24-25. 
** Courses  of  Study  in  Corporation  Finance 
and  Investment,"  9-10;  Loughy  70-104; 
Jordmi,  11-22. 

Founders  or  Managers  Shares.  Compara- 
tively new  in  this  country.  Usually  are 
common  shares  given  or  sold  to  managers 
or  employees.  Sometimes  provided  that  the 
shares  cannot  be  sold  except  to  the  company. 
These  shares  often  precede  ordinary  common 
in  case  of  liquidation.  Often  these  shares  are 
entitled  to  a  certain  proportion  of  entire 
distribution  of  surplus  earnings.  Object  in 
issuing  Founders  or  Managers  shares  to  give 
all  incentive  to  those  in  charge  of  a  corpora- 
tion to  develop  the  business.  Perfectly 
fair  unless  the  percentage  of  total  profits  to 

[6] 


these  shares  is  too  large.  Sometimes  all  com- 
mon shares  receive  stated  percentage,  e.g., 
7  per  cent. — then  Founders  or  Managers 
shares  receive  a  certain  percentage,  say  20, 
of  any  further  distributions. 

See  Lough,  83.  Tovey — Balance  Sheets, 
15-17.  For  Provisions  of  typical  Managers 
Shares  see  Gerstetiberg — Materials,  1013. 

Additional  citations  on  No  Par  Stock: 
Lough,  95;  Collver,  133.  Law  of  New  York 
State:  Gerste^iherg — Materials,  43-50. 

Bonus  Stock:  Lough,  91. 

Voting  Trust  Certificates:  Lough,  102-104. 

For   typical    agreement    see   Gerstenberg — 

Materials,  91-97. 
Cumulative  Voting:  Lough,  95-99. 

Kinds  of  Bonds  and  Notes. 

The  various  bases  of  classification,  covering 
all  classes  of  security  issuers,  including  indus- 
trials. Chamberlain,  69-114.  Annals — Lyo7i, 
6-1 1 ;  Jordan,  22-30;  Lozunhaupt,  14-35. 

It  is  notable  that  the  forms  of  industrial 
bonds  are  few  and  simple  in  comparison  with 
those  issued  by  railroads.  A  second  mort- 
gage industrial  bond  is  not  common.  In  se- 
curity the  industrial  bond  usually  jumps  from. 
a  first  mortgage  to  a  debenture.  Seldom  does 
an  industrial  have  more  than  three  or  four 
issues  of  bonds  and  notes  as  against  as  high 
as  fifty  to  sixty  for  some  railroads.  Annals — 
Moody,  76-77. 

[7] 


Ill 

Provisions  of  Preferred  Stocks 

The  Industrial  Securities  Committee  of  the 
Investment  Bankers'  Association  of  America 
made  in  19 19  a  most  helpful  report  in  regard  to 
preferred  stocks  and  their  covenants.  This  is 
given  below  complete. 

By  MAYNARD  H.  MURCH,  CHAIRMAN 

Of  Maynard  H.  Murch  Co.,  Cleveland 

The  Industrial  Securities  Committee  desires  to  direct 
the  attention  of  the  members  of  the  association  to  the  sub- 
ject of  preferred  stock  covenants.  We  have  not  made  a 
statistical  analysis  of  the  sale  of  preferred  issues,  but  every 
dealer  knows  how  great  the  volume  has  been  during  the 
last  two  or  three  years  and  the  tremendous  rate  at  which 
it  continues  to  grow.  The  committee  believes  that  there 
are  immediate  problems  for  the  association  to  consider  in 
order  to  obtain  the  best  results  from  this  new  department 
of  the  investment  securities  business. 

The  preferred  stock  method  of  financing  has  been  em- 
ployed, as  a  rule,  by  established  corporations,  for  the  pur- 
pose of  raising  capital  without  going  into  debt,  although, 
in  connection  with  common  bonuses,  it  has  been  used  fre- 
quently for  new  enterprises.  Corporations  have  been 
attracted  by  this  method  of  cleaning  up  old  debts  and  fur- 
nishing additional  funds  without  the  creation  of  other 

[8] 


debts,  as  a  means  of  paying  up  bank  obligations  and 
clearing  property  of  mortgages.  The  public  has  been 
attracted  by  the  substantial  investment  values  that  have 
been  provided  in  preferred  stocks  in  the  way  of  liberal 
income,  tax  exemptions,  and  protective  features,  as  well  as 
by  the  general  advantages  to  the  corporation.  Thus 
fostered  by  the  favor  of  both  issuer  and  purchaser  the 
movement  has  grown  and  rolled  up  in  surprising  volume. 

In  order  that  the  best  results  may  be  obtained  from  this 
movement  for  the  corporation,  and  therefore  the  best  re- 
sults for  the  investor,  the  committee  believes  that  the  best 
practices  to  be  followed  are  along  the  general  theory  of 
substituting  liens  on  the  management,  with  maturities 
payable  out  of  profits,  for  liens  on  tangible  property,  with 
fixed  maturities,  properly  safeguarded  by  covenants  which 
will  keep  the  tangible  property  intact  and  enable  the  pre- 
ferred stock,  if  the  management  should  fall  into  the  hands 
of  the  preferred  holders,  to  get  direct  access  to  the  aflPairs 
of  the  corporation  before  irreparable  damage  has  been 
done  by  the  dissipation  of  working  capital  and  the  creation 
of  excess  debts. 

If  this  theory  is  carried  out  by  giving  the  investment 
house  from  which  the  investor  purchases  his  securities 
monthly  financial  statements  covering  assets,  liabilities, 
sales,  collections  and  profits,  so  that  every  important 
change  in  the  affairs  of  the  corporation  may  be  known  at 
once,  and  representation  on  the  board  of  directors  with 
provision  for  monthly  meetings;  and  the  preferred  stock- 
holders be  given  authority  to  change  the  management 
through  controlling  stockholders'  meetings  in  the  event  of 
default  in  any  of  the  important  restrictions  of  the  issue, 
more  desirable  results  can  be  obtained  in  many  cases,  both 
from  the  standpoint  of  the  corporation  and  the  investor, 
than  by  financing  through  the  creation  of  debts;  provided, 
however,  the  investment  house  attends  conscientiously  to 
its  duties  in  watching  the  issue.  The  last  provision  is 
of  the  utmost  importance,  and  requires  particular  empha- 
sis during  such  times  as  these  when  industrial  houses  are 
apt  to  be  too  busy  with  new  issues  to  bother  about  the  old 
ones. 

[9] 


As  a  part  of  this  report  we  have  tabulated  various  meth- 
ods which  investment  houses  have  pursued  in  attempting 
to  obtain  the  foregoing  results.  A  few  of  the  important 
items  in  regard  to  the  protection  of  working  capital,  re- 
demption, voting  power,  and  the  issuance  of  prior  lien  se- 
curities deserve  special  comment. 

REDEMPTION — If  preferred  stocks  are  to  be  consid- 
ered investments  they  must  observe  the  rules  of  redemp- 
tion. Where  so  much  dependence  is  placed  upon  the 
personal  element  which  is  certain  to  change  every  few 
years,  and  may  change  overnight,  the  redemption  clause 
is  one  of  the  most  important,  but  because  of  state  and 
federal  laws  regarding  taxes,  and  the  necessity  of  consider- 
ing preferred  funds  as  a  more  or  less  permanent  form  of 
capital,  the  amounts  and  times  of  redemption  cannot  be 
fixed,  except  in  relation  to  earnings,  and  there  can  be  only 
partial  compliance  therefore  with  the  recognized  invest- 
ment rules  of  redemption.  The  most  important  points 
in  connection  with  the  redemption  of  preferred  issues  are 
the  time  of  beginning  redemption,  the  amount  to  be  re- 
deemed annually,  and  the  price  at  which  redeemed. 
A  corporation  which  has  been  refinanced  for  the  purposes 
of  extending  its  business  or  the  construction  of  new  plants 
should  be  permitted  to  have  the  use  of  the  new  funds  with- 
out redemption  requirements  until  these  funds  have  co;n- 
menced  producing;  otherwise  the  redemption  charge  is  a 
burden  on  the  old  capital  of  the  company.  We  consider 
it  well,  therefore,  to  allow  the  corporation,  under  such  cir- 
cumstances, a  reasonable  period,  to  be  determined  by  the 
conditions  of  each  case,  before  the  redemption  clause  is  in 
full  operation.  Another  way  of  treating  this  point  is  to 
specify  a  smaller  amount  to  be  redeemed  during  the  first 
and  second  years. 

The  total  amount  to  be  redeemed  each  year  depends 
upon  the  nature  of  the  business,  the  character  of  its  assets, 
whether  wasting  or  growing,  its  earning  power,  and  its 
capital  requirements. 

The  price  at  which  preferred  stocks  should  be  redeemed 
depends  upon  circumstances  which  vary  from  issue  to  issue, 

[10] 


but  this  feature  is  determined  largely  by  the  investment 
values  of  the  security.  A  highly  speculative  issue  may  be 
retired  at  a  larger  price  than  an  issue  containing  substantial 
investment  values.  Preferred  stockholders  of  a  corpora- 
tion engaged  in  a  hazardous  line  of  business  are  entitled  to  a 
good  profit  over  and  above  the  regular  rate  of  dividend 
on  their  stock  in  the  event  that  the  prosperity  of  the  issu- 
ing corporation,  based  largely  on  the  use  of  the  preferred 
stockholders'  money,  enable  it  to  retire  the  issue.  Sub- 
stantial non-speculative  issues  naturally  bear  a  smaller 
redemption  price,  except  in  cases  where  an  unusually  high 
rate  of  dividend  is  provided,  as  has  lately  been  the  case  in 
several  known  preferred  issues. 

It  has  been  customary  to  redeem  on  dividend  dates  only, 
and  to  require  from  60  to  90  days'  notice.  There  is  no 
particular  reason  why  preferred  stocks  should  be  redeemed 
on  dividend  dates,  because  this  requirement  does  not 
offer  any  particular  advantage,  either  to  the  issuing  cor- 
poration or  to  the  investor,  except  a  small  matter  of  book- 
keeping; nor  does  long-time  notice  seem  essential  from  the 
standpoint  of  the  investor,  if  the  redemption  premium  be 
sufficient.  Such  notice  certainly  is  not  essential  from  the 
standpoint  of  the  corporation.  It  seems  fair  to  all  parties 
concerned,  therefore,  that  preferred  stocks  should  be  called 
upon  reasonable  notice,  say,  30  days  prior  to  any  given  date. 
If  redemption  may  take  place  only  upon  a  dividend  date, 
there  might  be  several  months'  delay  before  legitimate 
financing  might  take  place,  where  the  element  of  time  was 
of  great  importance. 

NET  CURRENT  ASSETS— In  our  opinion  the  cove- 
nant in  regard  to  the  maintenance  of  net  current  assets  is 
one  of  the  most  important  to  be  provided  in  the  issuance  of 
preferred  stock.  It  is  the  deficiency  of  working  capital 
which  is  ordinarily  responsible  for  the  issuance  of  new  se- 
curities. This  deficiency  may  be  the  result  of  rapidly  ex- 
pending business  or  of  the  construction  of  new  buildings 
for  the  housing  of  old  business  or  the  result  of  losses  from 
the  operation  of  the  business,  accidents,  bad  credits,  etc. 

A  corporation  having  plenty  of  working  capital  seldom 

[II] 


is  required  to  sell  new  securities,  excepting  for  expansion  or 
extraordinary  purposes.  Any  covenant  which  has  to  do 
with  the  maintenance  of  the  proper  amount  of  working,  or 
current  capital,  is  therefore  of  the  utmost  importance. 
Most  preferred  stock  issues  read  that  the  amount  of  net 
current  assets  shall  be  equal  to  the  amount  of  outstanding 
preferred  stock.  Our  examination  of  many  cases  where  the 
covenant  is  worded  in  this  manner  fails  to  disclose  any 
particular  relation  between  the  current  capital  require- 
ments of  the  business  and  the  amount  of  the  preferred  stock 
outstanding,  although  in  some  cases  there  is  an  accidental 
relation,  notice  of  which  has  led  a  great  many  corporations 
to  provide  in  their  issues  that  the  amounts  shall  be  equal. 

As  a  matter  of  fact,  a  corporation  may  have  only  50 
per  cent,  of  its  preferred  stock  issue  represented  by  net  cur- 
rent assets  and  still  be  comfortably  supplied  with  working 
capital.  This  matter  depends  entirely  upon  the  nature  of 
the  business,  and  frequently  one  of  the  important  de- 
termining facts  is  the  length  of  credits.  In  a  certain 
line  of  business  where  credits  are  twenty-four  days  long, 
working  capital  requirements  are  much  smaller  than  where 
they  are  45  days.  While  it  may  answer  the  purpose 
m  a  haphazard  sort  of  way  to  fix  the  amount  of  net 
current  assets  to  be  maintained  at  100  per  cent,  or  125  per 
cent,  of  the  outstanding  preferred  stock  issue,  this  is  at 
best  a  makeshift  method  and  may  be  absolutely  unfair 
to  the  corporation  as  well  as  to  the  holder  of  preferred 
stock,  except  that  it  provides  enough  current  assets  to 
liquidate  preferred  stock  in  event  of  dissolution  of  the 
company,  which  the  investor  does  not  consider  as  one  of 
the  probabilities  when  he  buys  his  stock.  From  the  stand- 
point of  operating  the  business  the  covenant  in  regard 
to  the  maintenance  of  net  current  assets  should  be  drawn 
after  determining  the  required  amount  of  capital  for  a  cer- 
tain volume  of  business  and  by  careful  inspection  of  the 
records  of  the  business  for  a  long  period  of  years.  Such 
examination  will  clearly  show  how  much  business  may  be 
safely  done  per  dollar  of  capital  under  ordinary  conditions. 

The  committee  believes  that  it  adds  greater  safety  to 
the  mterest  of  the  preferred  stockholder  to  provide  just 

[12] 


enough  working  capital  to  run  the  business  safely,  rather 
than  to  burden  the  corporation  by  providing  a  great  deal 
too  much,  as  may  be  the  case  if  this  important  point  is  set- 
tled by  the  rule  of  thumb  method  of  stating  that  net  cur- 
rent assets  shall  be  equal  to  the  outstanding  preferred  stock 
issue.  A  survey  of  the  records  of  any  business  may  deter- 
mine that  the  amount  of  working  capital  required  to  keep 
the  corporation  out  of  excessive  debt  may  be  considerably 
in  excess  of  the  outstanding  preferred  stock  issue. 

The  method  of  determining  net  current  assets  should  be 
carefully  provided  in  the  covenants  of  the  issue  by  reciting 
the  items  which  shall  be  included,  as  well  as  those  items 
which  shall  be  deducted.  Without  this  detail  in  the  pre- 
ferred stock  contract  there  is  certain  to  arise  a  constant 
dispute  in  regard  to  the  matter  of  working  capital. 

ISSUANCE  OF  SENIOR  SECURITIES— The  issuance 
of  securities  having  priority  over  preferred  stock  is  of  ut- 
most importance  to  the  preferred  stockholders,  and  should 
be  treated  in  a  broad  and  positive  manner,  so  as  not  to 
prevent  the  corporation  from  turning  around  in  case  of 
emergency;  at  the  same  time  make  it  necessary  that  such 
securities  may  be  issued  only  after  full  consideration  of  all 
the  mterests  at  stake,  and  with  the  written  consent  of  a 
proper  proportion  of  the  amount  of  outstanding  preferred 
stock. 

To  provide  that  the  corporation  may  not  issue  securities 
of  prior  lien  under  any  circumstances  would  be  to  defeat  the 
theory  of  preferred  stock  financing,  and  might  bring  dis- 
aster upon  some  preferred  stockholders  whose  interests 
could  be  well  protected  by  the  proper  issuance  of  senior  se- 
curities issued  under  the  supervision  and  with  the  consent 
of  the  preferred  stockholders. 

One  of  the  great  differences  between  preferred  stock  and 
mortgage  financing  is  that  in  a  properly  drawn  issue  of  pre- 
ferred stock,  the  corporation  starts  out  with  a  clean  sheet, 
without  mortgage  obligation,  and  with  only  a  comfortable 
amount  of  current  debts,  and  when  the  day  of  serious  emer- 
gency arises  and  financing  through  preferred  or  common 
stocks  is  impossible,  there  is  still  left  open  the  opportunity 

[i3l 


of  creating  a  mortgage  on  fixed  property.  If  this  door  is 
closed,  disaster  might  be  certain  to  follow  to  preferred 
stockholders,  whereas  the  creation  of  a  mortgage  under 
the  supervision  of  the  preferred  stockholders  might  be 
ample  protection  for  their  investment. 

It  is  impossible,  of  course,  to  prevent  a  corporation  from 
owing  current  obligations  up  to  a  certain  reasonable 
amount,  which  amount  is  ordinarily  fixed  by  commercial 
banks  at  50  per  cent,  of  the  total  current  assets.  But  the 
question  often  arises  as  to  whether  or  not  in  a  tight  money 
market  it  is  not  advisable  to  permit  the  conversion  of  bank 
loans  into  notes  of  a  long  maturity.  A  great  majority  of 
preferred  stock  issues  provide  that  without  the  consent  of  a 
certain  proportion  of  the  preferred  stock  issue  no  obliga- 
tions having  a  longer  maturity  than  one  year  from  date 
shall  be  permitted.  As  between  90  day  paper,  for  the 
payment  of  which  the  corporation  is  being  pressed,  and  3 
year  paper,  which  is  riding  comfortably,  there  can  be  no 
choice  as  far  as  the  corporation  itself  is  concerned,  but 
from  the  standpoint  of  the  preferred  stockholder  it  is  not 
always  safe  to  permit  a  corporation  to  convert  its  bank 
loans  to  long-time  obligations,  although  thereby  there  may 
be  created  no  increase  in  the  total  amount  of  indebtedness, 
because  at  that  stage  of  the  company's  business,  where  this 
conversion  seems  advisable,  it  may  be  wise  for  the  preferred 
stockholders  to  make  a  new  survey  of  the  situation  to 
determine  whether  the  failure  of  the  corporation  to  keep 
out  a  reasonable  amount  of  90  day  paper  is  due  to  some  im- 
portant fact  of  which  recognition  should  previously  have 
been  made.  On  the  other  hand,  such  conversion  may  be 
advisable  if  the  total  amount  of  debt  is  otherwise  carefully 
guarded. 

This  is  a  difficult  point  to  discuss  with  the  manager  of  a 
corporation,  who  ordinarily  can  see  the  difference  between 
short-time  and  long-time  notes  as  a  matter  of  time  only, 
with  the  preference  for  the  long  time,  but  if  this  point  of 
conversion  is  left  uncovered  the  preferred  stockholder  may 
miss  an  opportunity  of  compelling  the  common  stock- 
holders to  assist  in  financing  the  corporation  up  to  the 
point  where  there  is  a  reasonable  balance  between  the 

[14I 


amount  of  money  furnished  by  the  preferred  stockholders 
and  the  common  stockholders  and  the  commercial  banks. 
No  harm  is  done  to  preferred  stockholders  by  the  allowance 
of  purchase  money  mortgages,  subsequent  to  the  issuance 
of  preferred  stock,  where  the  amount  of  mortgage  is  for 
only  a  reasonable  portion  of  the  property  purchased. 

Restrictions  on  the  creation  of  prior  lien  securities  should 
also  include  the  guaranteeing  of  the  credit  obligations  or 
securities  of  subsidiary  or  allied  corporations,  whatever 
may  be  the  consideration  for  which  such  guarantees  might 
be  created.  Even  in  cases  where  the  entire  capital  stock 
of  a  subsidiary  or  allied  corporation  may  be  owned  by  the 
issuing  corporation,  it  is  important  for  preferred  stock- 
holders to  provide  that  the  relations  between  the  two  cor- 
porations shall  be  maintained  on  standard  financial,  busi- 
ness, and  legal  lines.  Otherwise,  preferred  stockholders 
may  some  day  wake  up  to  find  that  their  corporation  has 
been  lending  raw  material  or  money  or  credit  to  a  subsi- 
diary corporation,  and  the  subsidiary  corporation  may 
be  disposed  of  by  the  directors  of  the  issuing  corporation 
in  a  way  that  is  disadvantageous  to  the  holders  of  the  pre- 
ferred stock  issue.  It  is  impossible  for  preferred  stock- 
holders to  guarantee  themselves  against  the  most  infamous 
forms  of  mismanagement  and  milking,  unless  the  covenants 
of  their  contract  carefully  cover  the  matter  of  relations 
with  subsidiary  corporations. 

VOTING  POWER  AND  PENALTIES— It  has  been 
the  habit  of  the  old-time  bond  investor  to  consider  pre- 
ferred stocks  as  "easy  going,"  and  to  the  extent  that  the 
covenants  are  not  properly  supported  by  sufficient  voting 
power  to  enforce  them,  this  criticism  is  true.  The  com- 
mittee has  found  a  surprisingly  large  number  of  issues 
which  do  not  provide  voting  power  sufficient  to  give  the 
preferred  stockholder  any  authority  whatever  in  the  event 
of  default  in  any  of  the  important  covenants  of  the  con- 
tract. Except  for  the  fact  that  the  preferred  stockholder 
obtains  a  more  liberal  income  from  the  issuing  corporation 
than  the  bondholder,  there  is  no  reason  whatever  for  surren- 
dering his  right  to  register  properly  a  protest  in  the  event 

[IS] 


that  his  Investment  is  damaged.  Yet  in  many  cases  the 
preferred  stockholder  is  left  without  voting  power,  or  with 
only  sufficient  voting  power  in  the  event  of  default  to  put 
him  on  an  equal  footing,  or  what  appears  to  be  an  equal 
footing,  with  the  common  stockholder  who  is  responsible 
for  the  default. 

Equal  voting  power,  between  preferred  and  common 
stock,  simply  means  that  the  preferred  stockholder  has  an 
admission  ticket  which  is  no  good,  because  the  common 
stockholder,  by  the  purchase  of  a  few  shares  of  the  pre- 
ferred, easily  accomplished  when  trouble  is  brewing,  has 
complete  authority  to  continue  his  administration  and 
the  abuses  which  have  impaired  the  interest  of  the  preferred 
stockholder.  In  the  event  that  these  abuses  or  accidents, 
whichever  may  be  the  proper  term  under  the  circumstances, 
have  been  beyond  the  control  of  the  common  stock  man- 
agement, the  preferred  stockholder  with  a  larger  vote  than 
50  per  cent,  would  probably  make  matters  worse  by  at- 
tempting to  exercise  his  authority,  but  in  all  other  forms 
of  investment  where  the  income  is  limited,  the  investor  is 
given  the  opportunity  of  deciding  what  shall  be  done  about 
the  payment  of  the  obligations  due  him,  and  in  the  case 
of  preferred  stocks,  if  he  so  chooses,  he  has  a  free  hand  to 
caucus  his  interests  with  the  common  stockholder  for  the 
consideration  of  proper  remedies,  and  it  is  not  necessary, 
although  it  may  be  his  right,  that  he  should  upset  the  man- 
agement which  has  been  unfortunate  rather  than  incom- 
petent. 

In  the  case  of  incompetent  management,  which  threatens 
the  security  of  the  preferred  stockholder's  investment,  no 
remedy  is  sufficient  except  voting  power  which  controls 
without  question  the  proceedings  of  the  stockholders'  meet- 
ing. A  director  once  elected  cannot  be  removed  until  the 
expiration  of  his  term,  and  if  he  represents  the  common 
stockholder  as  against  the  preferred,  it  is  not  at  all  probable 
that  he  will  resign.  It  is  therefore  difficult  for  the  preferred 
stockholders,  even  with  a  controlling  vote,  to  get  immedi- 
ate control  of  the  executive  machinery  of  a  corporation, 
but  a  stockholders'  meeting,  which  is  held  at  the  first  dis- 
covery of  signs  of  danger,  certainly  will  have  a  proper  re- 

[16] 


straining  effect,  and  perhaps  put  the  preferred  stockholders 
-in  position  to  resort  to  ordinary  processes  of  law  which 
would  be  sufficient  until  the  holding  of  the  annual  meeting. 

It  does  not  appear  to  the  committee  to  be  so  much  a  ques- 
tion as  to  what  the  proper  voting  power  should  be,  because 
every  investment  dealer  wants  it  to  be  sufficient  for  the 
protection  of  his  clients,  but  it  is  more  a  question  of  how 
to  enforce  the  proper  remedies  with  an  unfriendly  board 
of  directors  still  in  control.  This  has  been  accomplished 
in  many  cases  where  the  common  stock  is  closely  held,  and 
agreements  to  that  effect  more  readily  obtained,  by  pro- 
viding that  in  case  of  certain  aggravated  defaults  the  pre- 
ferred stockholder  should  be  permitted  to  call  meetings  of 
stockholders  and  to  obtain  immediately  the  resignation  of 
directors  so  that  they  might  proceed  forthwith  to  the  elec- 
tion of  their  own  officials.  Upon  the  correction  of  the 
default,  the  common  stockholder  is  again  returned  to  au- 
thority. This  remedy  is  effective,  because  it  is  quick; 
it  saves  waste  of  time  and  property  and  prevents  the  dis- 
integration of  the  business.  It  is  the  extreme  measure  as 
contrasted  with  the  almost  useless  provision  of  equal  voting 
power,  and  the  extent  to  which  it  should  be  employed  de- 
pends entirely  upon  the  circumstances  surrounding  such 
issue. 

The  committee  recommends  that  in  the  great  rush  to 
purchase  preferred  issues  the  members  of  the  association 
do  not  overlook  the  important  matter  of  providing  proper 
voting  penalties  for  the  enforcement  of  the  covenants  of 
the  contract.  The  present  preferred  stock  movement  will 
finally  be  declared  a  success  or  failure  as  proper  voting 
control  is  provided  for  the  protection  of  the  preferred  stock 
buying  public. 

The  committee  acknowledges  the  assistance  of  Mr.  Luigi 
Criscuolo,  of  Merrill,  Lynch  &  Company,  in  the  preparation 
of  the  following  tabulation  of  preferred  stock  covenants  in 
common  use: 

MAINTENANCE    OF   NET  CURRENT  ASSETS 

Amount  usually  fixed  at  certain  per  cent,  of  preferred 
stock  outstanding,  depending  upon  requirements  of  busi- 

[i7l 


ness,  ranging  from  50  per  cent,  in  cases  where  credits  are 
short  and  inventories  small,  to  200  per  cent,  in  cases  where 
fixed  property  is  rented  and  credits  long  and  inventories 

large- 

Sometimes  fixed  at  amount  sufficient  to  liquidate  pre- 
ferred stock  issue  without  reference  to  capital  requirements 
of  business. 

Usually  stipulated  what  commercial  current  items  shall 
be  included,  what  prices  allowed  on  all  classes  of  merchan- 
dise and  what  reserves  and  obligations  deducted. 

Penalty  for  violation  of  agreement  usually  severe. 

VOTING   POWER   AND    PENALTIES 

In  case  of  default  in  principal  covenants,  preferred  stock 
usually  has  voting  power,  ranging  from  50  per  cent,  to 
100  per  cent.,  but  some  issues  provide  equal  share  for  share 
vote  with  common  at  all  times.  Voting  power  usually 
terminates  with  correction  of  default.  Laws  of  each  state 
make  various  provisions  necessary. 

RESTRICTION   OF   SENIOR   SECURITIES 

Provision  made  that,  without  securing  permission  of 
holders  of  certain  proportion  (two-thirds  or  three-quarters, 
more  or  less)  of  preferred  stock  outstanding,  the  company 

may  not: 

1.  Create  any  stock  which  has  prior  or  equal  charge  on 
earnings  or  assets. 

2.  Create  any  mortgage  on  property  of  company  or 
issue  any  bonds  secured  thereunder,  except  purchase  money 
mortgages. 

3.  Issue  or  guarantee  any  bonds,  notes,  or  other  evi- 
dences of  debt  which  mature  later  than  one  year  from  date 
of  issue. 

DIVIDEND   PROVISIONS 

No  dividends  to  be  paid  on  common  stock  until  all 
accrued  and  unpaid  dividends  on  preferred  stock  shall  have 
been  paid,  nor  unless  net  current  assets  restrictions  have 
been  fully  complied  with. 

[18] 


No  common  dividends  to  be  paid  until  foregoing  pro- 
vision has  been  complied  with  and  further  until  certain 
amounts  have  been  set  aside  for: 

1.  Retirement  of  certain  proportion  of  preferred  stock 
each  year. 

2.  Creation  of  surplus  fund  to  be  used  as  guarantee 
fund  for  dividends  or  retirement  charges  on  preferred  stock. 

In  case  of  default  in  dividends  on  preferred  stock,  holders 
of  same  are  given  authority  to  elect  a  majority  of  the  board 
of  directors  until  such  time  as  default  has  been  cured.  In 
some  cases,  where  preferred  holders  have  no  voting  power, 
they  are  given  equal  power  with  common  stock  until  de- 
fault is  cured. 

After  preferred  stock  has  received  a  specified  amount 
and  the  common  stock  a  specified  amount,  the  balance  is 
to  be  declared: 

1.  Equally  divided  between  preferred  and  common. 

2.  Given  to  the  common  alone. 

3.  Smaller  proportion  given  to  preferred  than  to  com- 
mon. 

SUBSCRIPTION   RIGHTS 

If  any  additional  issue  of  common  stock  shall  be  made  by 
company,  preferred  stockholders  shall  be  given  privilege 
of  subscribing  to  same  ratably  with  common  stockholders. 

In  some  cases,  this  provision  is  expressly  waived  and 
only  common  stockholders  are  given  this  right. 

RESTRICTIONS    AS   TO   CHANGE    IN    BUSINESS 

Without  consent  of  holders  of  a  certain  amount  of  pre- 
ferred stock  (usually  75  per  cent.),  the  company  may  not: 

1.  Change  purpose  for  which  the  company  was  or- 
ganized. 

2.  Dispose  of  the  assets  and  business  in  entirety. 

DISTRIBUTION    OF    ASSETS     UPON    LIQUIDATION:     WHETHER 
VOLUNTARY   OR    BY   REASON   OF    BANKRUPTCY 

Upon  dissolution,  liquidation,  consolidation,  or  merger, 
preferred  stock  shall  be  entitled  to  receive  a  certain  amount 

I  19] 


per  share,  usually  the  redemption  price,  plus  all  accrued 
dividends,  before  anything  is  paid  on  the  common  stock. 

The  amount  received  is  in  many  cases  larger  in  case  of 
voluntary  dissolution  or  merger  than  in  case  of  bankruptcy 
where  it  is  often  par  and  accrued  dividends. 

RETIREMENT    OF   PREFERRED    STOCK 

Preferred  stock  may  be  retired: 

1.  As  a  whole, 

2.  In  certain  amounts,  such  as  percentage  of  issue,  or 
percentage  of  earnings. 

3.  As  a  whole  or  in  part,  at  a  certain  price  and  accrued 
dividends, 

1.  On  any  dividend  date. 

2.  On  30  to  90  days'  notice. 
Conditional  on: 

1.  Earnings, 

2.  Common  stock  dividends. 
By  call  or  private  purchase. 

In  some  cases,  when  a  preferred  stock  is  called,  privilege 
is  given  to  preferred  stockholders  to  convert  their  stock 
into  common  before  a  certain  date. 

Preferred  stock  is  called  for  payment  in  most  cases  on 
any  dividend  date,  it  being  convenient  to  pay  the  full 
accrued  quarterly  dividend  for  the  period.  This  may  be 
regarded  as  a  drawback  in  cases  where  the  company  wishes 
to  consummate  a  piece  of  financing  before  dividend  date 
arrives,  but  three  months'  interval  between  dividends  is 
often  consumed  in  shaping  up  a  financial  plan. 

SALE    OF    ADDITIONAL    PREFERRED    STOCK    OF    SAME    ISSUE 

Amount  not  to  be  increased  without  permission  of  hold- 
ers of  certain  proportion  of  present  stock,  usually  75  per 
cent,  in  writing,  unless  following  conditions  are  met: 

1.  Net  current  assets  are — per  cent,  of  preferred  out- 
standing. 

2.  Net  tangible  assets  are — per  cent,  of  preferred  out- 
standing. 

3.  Earnings  for  past  3  years  were  equivalent  to — times 

[20] 


dividend  on  preferred  outstanding  including  that  to  be 
issued. 

These  conditions  vary  with  nature  of  the  business  fi- 
nanced. 

SINKING    FUNDS 

Sinking  fund  of — per  cent,  of  preferred  stock  outstand- 
ing is  created  as  a  charge  on: 

1.  Net  income  before  dividends  on  preferred. 

2.  Net  income  after  dividends  on  preferred  before  pro- 
viding for  common  dividends. 

For  retirement  each  year  of  preferred  stock  at  not  ex- 
ceeding a  certain  price. 

In  certain  cases,  funds  of  this  character  are  not  to  be 
included  in  current  assets  of  the  company. 

The  sinking  fund  provision  is  usually  arranged  so  that 
in  a  certain  number  of  years  all  preferred  stock  will  be  re- 
tired, averaging  from  12  to  20  years. 

CONVERSION 

Often  preferred  stocks  have  the  privilege  of  being  con- 
verted into  common  stock  at  a  certain  time  and  rate. 
This  enables  the  purchaser  to  own  a  stock  having  better 
security  than  the  common  stock,  and  having  the  advan- 
tage of  possible  profitable  convertibility  into  common. 

SURPLUS 

Maintenance  of  surplus  at  certain  minimum  amount  is 
important  as  protection  against  impairment  of  credit  and 
ability  to  pay  preferred  dividends,  usually  fixed  by  stating 
that  common  dividends  shall  be  payable  out  of  earnings 
subsequent  to  certain  date,  or  by  requiring  that  certain 
relation  be  maintained  between  surplus  and  preferred 
stock  charges. 

TRANSFER  AND    REGISTRATION 

In  few  cases  only  do  corporations  transfer  their  own 
securities.     Appointment  of  separate  trust  companies  or 

[21] 


banks  with  special  departments  for  such  'work  is  advisa- 
ble for  transfer  and  registration. 

AUDITS   AND   CURRENT  REPORTS 

Audits  by  certified  public  accountants,  annual  or  more 
frequent,  dependent  upon  nature  of  business,  with  inven- 
tories taken  by  actual  count,  and  monthly  or  quarterly 
statements  signed  by  proper  officials. 

REPRESENTATION   ON    BOARD   OF   DIRECTORS 

Usually  provided  that  investment  house  shall  select  at 
least  one  member  of  board  of  directors  to  represent  inter- 
ests of  preferred  stock. 

directors'   MEETINGS 

Monthly  or  quarterly  meetings  of  directors  are  provided, 
as  circumstances  may  dictate. 


In  case  the  corporation  wishes  to  have  the 
preferred  issue  Hmited  to  dividend  of  a  certain 
per  cent,  per  annum,  the  certificate  should 
plainly  state  the  hmitation.  Should  state 
"and  no  more,"  or  "never  exceeding  in  one 
year."  Otherwise  court  may  construe  that 
dividends  be  equally  divided  after  preferred  divi- 
dend. 

"The  Corporation  Journal."  February,  1920. 
Page  108. 

Some  cumulative  preferred  stock  certificates 
provide  that  not  only  will  preferred  holders  be 
given  equal  voting  power  with  the  common  upon 
default  in  dividends  or  sinking  fund  provisions, 
but  that  in  case  of  several,  i.e.,  six  successive 
quarterly  dividends  or  two   successive  annual 

[22] 


sinking  fund  payment  defaults,  the  entire  voting 
power  be  vested  in  the  holders  of  preferred  stock. 

In  regard  to  a  callable  or  redemption  feature, 
it  is  evident  that  the  market  price  of  the  stock 
is  not  apt,  under  any  conditions,  to  advance 
above  this  figure.  If  other  securities,  i.e., 
long-term  bonds  or  non-callable  preferred  stocks 
of  equal  merit,  sell  to  yield  equally  well  when  a 
callable  preferred  sells  around  the  redemption 
figure  the  holder  of  the  latter  may  well  con- 
sider an  exchange  if  interest  rates  promise  to 
work  lower.  Otherwise  the  holder  may  find 
his  preferred  stock  called  in  at  some  future  time 
and  be  unable  to  reinvest  to  good  advantage, 
owing  to  the  advance  in  the  market  of  other 
securities. 

See  Lough,  76-82;  Collver,  1 37-141. 

For  example  of  preferred  stock  provisions  see 
Gerstenberg — Materials,  107-110. 


[23] 


IV 

Industrial  Mortgages 

1.  Analysis  oj  the  Indenture. 

2.  Rights  and  Duties  of  Corporate  Trustees. 
See  Lilly  for  complete  treatise.     See  also 
Lozunhaupt,  140-152;  Lough,  133-136.    For 
text  of  typical  industrial  bond  and  mortgage 
see  Gerstenberg — Materials,  183-254. 


[24I 


Background  of  Industrial  Corporation  Pros- 
perity 

I.     General  Business  Factors. 

(A)  Integration  and  Sources  of  Supplies 
Collver,  31-35;  Jordan,  182-183. 

Advantage  in  controlling  sources  of  raw 
materials. 

Examples  of  well-integrated  companies. 

Limit  to  capital  to  be  tied  up  in  raw  ma- 
terial. 

Sometimes  does  not  pay  to  try  to  control 
sources  of  raw  materials.  The  "assem- 
bly" idea. 

Difficulties  in  obtaining  raw  materials. 

Integration  by  amalgamation. 

(B)  Location. 

Location  has  recently  become  a  matter 
of  great  importance  to  many  corporations 
which  hitherto  were  not  vitally  concerned. 
The  drastic  increases  in  freight  rates  ef- 
fective September  i,  1920,  have  a  tendency 
to  discourage  long  hauls  of  heavy  or  light 

[25] 


but  bulky  raw  and  finished  products  and  to 
encourage  local  manufacture.  However, 
no  conclusion  can  be  made  as  to  the  eflfect 
of  the  new  rates  upon  any  one  corporation 
without  a  careful  analysis  of  the  situation — 
and  an  observance  as  to  the  actual  effect 
of  the  changed  conditions. 

Collver,  37-39;  Jordan,  99. 

Location  often  a  matter  of  chance:  i.e., 
the  residence  of  the  inventor  of  an  ar- 
ticle. 

May  or  may  not  be  of  importance.  Ex- 
amples. 

Advantage  in  demand  from  all  parts  of  the 
country. 

(C)  Standardization. 

C Oliver,  37. 
Necessity  in  certain  industries.     Examples. 

(D)  Fluctuation  in  Demand. 
Collver,  21-23,  Jordan,  184. 

Satisfy  a  broad,  growing  demand  ? 

Sell   to   all   classes   in    large   volume  with 

small  margin  of  profit? 
Affected  by  seasonal  weather  conditions? 
Depend  upon  general  prosperity? 
Depend  upon  local  or  transitory  conditions? 
Liable    to    be    affected    by    revolutionary 

changes  in  demand? 
Depend  upon  style  or  fad  ? 
[26] 


(E)  Diversification. 
Collver,  23-29. 

Diversification  of  products  sometimes 
counteracts  a  tendency  to  swing  between 
poverty  and  over-supply  of  business. 
Examples. 

(F)  Competition, 

Dewing,    523-529,  561-569;   Collver,  41- 
45;  Cooper,  149-162. 

Conditions  of  extreme  competition  forced 
the  inception  of  early  consolidation. 

Advantage  of  monopoly  was  expected. 
Usually  expectation  did  not  work  out. 

Size  of  corporation  often  not  of  import- 
ance in  consolidation. 

Monopoly  possible  through  unusual  busi- 
ness ability,  control  of  raw  products, 
patents,  or  trademarks.    Examples. 

Large  profits  certainly  invite  competition. 

Except  in  certain  instances  during  ab- 
normal prosperity,  competition  becomes 
more  keen  and  profits  per  dollar  of  gross 
sales  tend  to  grow  smaller.     Examples. 

Competition  of  similar  products  derived 
from  different  raw  materials. 

Escape  from  dangerous  competition  by 
changing  line  of  products. 

.     Factors  of  Management. 

(A)  Personal  Equation. 

Most  large  industrials,  like  other  institu- 

[27] 


tions,  "but  the  lengthened  shadow  of  a 
single  man."     Examples. 
Examples   of  unusual   success   because   of 
unusual  management. 

Life  insurance  as  a  protection  when  success 
dependent  upon  one  man  or  a  few  men. 

Tendency  toward  standardization  of  per- 
sonnel. 
Colher,  47-49;  Jordan,  177. 

Difficulties  in  securing  efficient  manage- 
ment for  very  large-scale  enterprise. 

Dewing,  559-560. 

Prosperous  small  business  may  be  ruined  by 
addition  of  new  capital. 

Large-scale  enterprises  may  have  manage- 
ment entirely  without  ability.  Exam- 
ples. 

Able  management  will  protect  itself  in 
raw  materials  by  hedging  or  buying  at  ad- 
vantageous times — will  take  advantage  of 
changes  in  business  and  financial  conditions. 
If  a  corporation  has  recently  been  recapi- 
talized, it  is  important  to  know  whether  the 
management,  if  of  large  caliber,  will  re- 
main. 

Collver,  50-54. 

(B)  Financial  Control — Underwriters — Direc- 
tors— and  Standing  of  Stockholders. 

Importance  of  control,  e.g.,  whether  con- 
trolling interests,  i.e.,  officers  and  directors, 

[28] 


are  successful  and  trusted,  and  whether  at 
least  part  of  these  men  are  practical  men  in 
the  special  line  pursued  by  the  corporation. 

Strong  control  will  often  see  a  corporation 
through  from  economic  failure  to  success. 

CollveTy  57. 

Work  of  directors.  Tendency  toward 
demanding  real  service  from  all  of  them 
and    giving    them    material    recompense. 

Lough,  37-44. 

Many  a  promising  corporation  has  been 
ruined  through  having  its  securities  handled 
by  a  weak  or  untrustworthy  security  house. 
Perhaps  the  first  test  of  a  security  is  to  see 
that  it  is  sponsored  by  one  or  more  strong 
and  reliable  investment  firms.  Moreover, 
it  is  desirable  that  the  entire  issue,  if 
newly  offered,  be  underwritten y  if  possible — 
so  that  the  corporation  may  be  certain  of 
its  money,  although  under  certain  condi- 
tions this  is  not  practical. 

The  standing  of  stockholders  in  certain 
instances  may  be  important,  but  not  at 
all  conclusive,  as  well-regarded  men  may  be 
given  a  security,  or  purchase  it  as  mere 
speculation,  which  is  offered  as  an  invest- 
ment to  others. 

(C)  Contracts  and  Alliances. 
Collver,  58-59. 

Relation  in  regard  to  the  raw  material 
furnishers — pleasant  ? 

[  29  1 


Are  raw  material  contracts  fair  to  all 
concerned  and  so  worded  as  to  avoid  hard- 
ship to  either  side  in  case  conditions  ma- 
terially change? 

Alliances  and  understandings,  as  far  as 
legal,  with  complementary  or  competing 
firms  may  be  desirable. 

(D)  Financial  Policy. 

A  corporation's  financial  policy  should  be 
judged  the  same  as  an  individual's;  it  is 
no  more  difficult  to  understand.  Examples 
of  careful,  conservative  policy. 

Over-liberal  dividend  policy  simply  an 
error  of  judgment  or  adopted  for  ulterior 
purposes.  Stability  essential  to  the  inves- 
tor. 

Colher,  61-64;  Loughy  435-457  and  478- 
479.     Gerstenberg — Principles,  162-167. 

Too  conservative  a  policy  not  suited  to 
the  investor  who  requires  return. 

Saliers — Financial  Statements,  90-91; 
Gerstenberg — Principles,  164-165. 

Reckless  policy  of  early  combinations. 
Dewing,  549-551;  Colher,  64.-6J. 

In  regard  to  declaring  dividend  see  Hat- 
field, 195-232;  Lough,  463-464;  and  Gersten- 
berg— Principles,  162-164. 

Initial  recklessness  may  be  followed  by 
genuine  and  deserved  prosperity  after  a 
period  of  careful  saving — the  same  as  with 
individuals.     Colher,  66-67. 

I30] 


Stock  dividends.  Recently  many  large 
stock  dividends  have  been  declared.  Such 
dividends  simply  reduce  the  surplus  per 
share  of  stock  through  increasing  the  num- 
ber of  shares.  It  is  quite  possible  that  the 
dividend  drain  on  some  corporations  which 
have  multiplied  the  amount  of  stock  and 
maintained  the  dividend  percentage  on  the 
whole  may  prove  too  severe  in  a  sub- 
normal period  of  business  to  allow  the 
dividend  to  be  maintained   indefinitely. 

Small  stock  dividends,  even  when  dis- 
bursed with  some  degree  of  regularity, 
usually  a  more  conservative  plan.  Com- 
panies such  as  certain  of  the  Standard  Oils, 
which  maintain  small  dividends  compared 
with  large  assets  and  great,  well-maintained 
earnings,  can  issue  stock  dividends  of 
material  size  without  endangering  the 
regular  disbursements,  and  a  broader  mar- 
ket results  from  the  increased  number  of 
shares. 

Stock    rights.     Rights    to    subscribe    to 
stock  are  often  sold.     The  advisability  of 
doing  so  depends  upon  the  condition  of  the 
company  and  general  conditions. 
See  ZoMg/z,  459-463 ;  Lyon,  II,  193-195. 

Script  Dividends — Declared  to  main- 
tain regular  dividends  while  conditions  are 
unfavorable  for  cash  disbursements.  Lough, 
458. 

Property    Dividends — Division    of    un- 

[31] 


needed  assets,  e.g.,  investments.      Gersten- 
herg — Principles,  167-168. 

(E)  Loyalty  and  Cooperation. 

Collver,    55-56;  Sfl/zVrj-Financial   State- 
ments, 94-95. 

Importance  in  industrial  success.  Ex- 
amples of  means  taken  by  leading  corpo- 
rations to  secure  the  best  efforts  of  the  en- 
tire organization. 

(F)  Good  Business  Methods. 
Collver,  2-4. 

General  policies. 
Accounting — including  cost.  A  corpo- 
ration must  have  a  well-designed  and  exe- 
cuted accounting  control  in  all  departments 
in  order  that  it  be  managed  properly  and 
adequate  reports  be  available  for  stock- 
holders. 

Effect  of  Associations. 


[32I 


VI 

Policy  of  Publicity 

Examples  of  companies  which  give  frequent 
reports  to  the  public.  New  York  Stock  Ex- 
change requirements  and  efforts  for  additional 
publicity. 

Unless  complete  and  frequent  reports  are 
available  the  securities  of  a  corporation  cannot 
be  analyzed  with  any  degree  of  satisfaction. 
Corporation  officials  now  realize  that  secrecy 
does  not  prevent  "undesirable  speculation'* 
but  is  necessary  to  the  protection  of  the  secur- 
ity holder.  Investment  and  intelligent  specu- 
lation are  possible  only  as  frequent  and  com- 
plete information  as  to  income  and  financial 
condition  are  available.  Gambling  is  the  stak- 
ing of  money  on  the  unknown. 

Collver,  I.  5-7;   Tovey — Balance  Sheets,  1-9. 

Some  underwriting  contracts  now  provide 
that  a  reputable  accounting  firm,  agreeable  to 
the  underwriters,  be  appointed,  that  complete 
and  frequent  statements  be  issued  by  the  cor- 
poration, that  at  least  the  annual  reports  of 
income  and  financial  condition  be  certified  by 

[33] 


the  chosen  accounting  firm,  and  that  the  under- 
writers be  permitted  to  have  the  accountants 
go  over  the  books  of  the  corporation  at  any 
time  between  the  annual  periods. 

As  an  additional  safeguard  to  assure  com- 
plete publicity  to  the  security  holder,  it  has  been 
suggested  that  underwriters  provide  in  their 
contract  with  a  company  issuing  new  stocks  or 
bonds  that  the  company  shall  furnish  and  file 
with  the  registrar  or  trustee  semi-annually  an 
audit  containing  Balance  Sheet  and  Income  Ac- 
count certified  by  accountants  approved  by  the 
registrar  or  trustee.  It  has  also  been  suggested 
that  copies  of  this  audit  be  available  to  every 
security  holder  upon  request. 

Some  underwriters  also  insist  upon  at  least  one 
representative  on  the  board  of  directors,  in 
order  to  safeguard  continuously  the  interests 
of  their  customers.  Collver^  203;  Murch — See 
report  of  the  Industrial  Securities  Committee 
of  Investment  Bankers'  Association  of  America 
given  in  full  on  pages  8-22. 

One  large  security  house  has  suggested  that 
corporations  be  obliged  to  report  from  year  to 
year  in  accordance  with  the  statements  re- 
quired by  the  New  York  Stock  Exchange  pre- 
liminary to  listing. 

See  Haney,  390-392;  Lough,  34-37.  For 
unusually  frank  annual  report  see  Gerstenherg — 
Materials,  627-662. 

See  also  VII,  Pages  35-41  and  XII,  i,  2,  3, 
Pages  73-76. 

[34] 


VII 

Accounts.     General 

I.     Lack   of   Uniformity   in   Accounting   and 
Published  Reports. 

Accounting  methods  are  apt  to  differ 
according  to  the  relative  prosperity  of  a  cor- 
poration. In  times  of  unusual  prosperity 
conditions  are  sometimes  better  than  apparent 
from  pubhshed  accounts;  in  times  of  depres- 
sion, less  favorable. 

Unfortunately  no  uniform  systems  of  ac- 
counting or  published  reports  are  in  use. 
Owing  to  the  various  kinds  of  industrial 
activity,  various  standard  systems  will  be  re- 
quired. 

Collvery  69-70;  Saliers — Financial  State- 
ments, 20,  31. 

The  Federal  Reserve  Board,  Washington, 
has  published,  in  its  bulletin  of  April,  1917, 
an  approved  method  for  the  preparation  of 
Balance  Sheet  statements  with  proposed 
Income  Account,  as  well  as  a  proposed  Bal- 
ance Sheet.  This  material  is  a  reprint  of 
information  and  data  acquired  by  the  Fed- 

[35] 


eral  Trade  Commission  from  the  American 
Institute  of  Accountants.  The  proposed 
balance  sheet  is  given  on  pages  36-37  and  the 
income  account  on  page  76.  While  helpful 
in  suggestion  (as  is  the  supplementary  ma- 
terial in  the  Bulletin)  Balance  Sheets  as  given 
in  most  of  the  corporation  annual  reports  are 
in  much  different  form,  and  the  items  will 
be  covered  hereafter  more  in  accordance  with 
typical  practice. 

For  typical  Balance  Sheet  in  conventional 
form  reasonably  complete,  with  supporting 
schedules  from  Collver^  76-79,  see  pages  38-39. 
See  also  Wildman,  285-295. 

Both  Income  Account  and  Balance  Sheet 
figures  are  necessary  for  analysis.      Collver, 

7S-7^' 

FORM    OF    BALANCE    SHEET 


ASSETS. 

CaKh: 

la.  Cash  on  hand — currency  and 

coin, 
lb.  Cash  in  bank. 

Notes  and  accounts  receivable: 
3.  Notes  receivable  of  customers 

on  hand  (not  past  due). 
5.  Notes  receivable  discounted  or 
sold    with    indorsement     or 
guaranty. 
7.  Accounts  receivable,  custom- 
ers (not  past  due). 
9.  Notes    receivable,    customers, 
past  due  (cash  value,  $       ). 
11.     Accounts      rt-ceivable,      cus- 
tomers, past  due  (cash  value 
$  ). 

Less: 

13.  Provisions  for  bad  debts. 
15.  Provisions    for    discounts, 
freights,  allowances,  etc. 


LIABILITIES. 

Bills,  notes,  and  accounts  payable: 
Unsecured  bills  and  notes — 
2.  Acceptances  made  for  mer- 
chandise or  raw  material 
purchased. 
4.  Notes       given      for      mer- 
chandise or  raw  material 
purchased. 
6.  Notes   given   to   banks   for 

money  borrowed. 
8.  Notes  sold  through  brokers. 
10.   Notes  given  for  machinery, 

additions  to  plant,  etc. 
12.  Notes  due  to  stockholders, 
officers,  or  employees. 
Unsecured  accounts — 
14.  Accounts   payable   for   pur- 
chases (not  yet  due). 
16.  Accounts  payable   for   pur- 
chases (past  due). 
18.  Accounts  payable  to  stock- 
holders,   officers,    or    em- 
ployees. 


[36] 


ASSETS — Cont. 

Inventories: 

17.  Raw  material  on  hand. 

19.  Goods  in  process. 

21.  Uncompleted  contracts. 

Less   payments   on   account 
thereof. 
23.  Finished  goods  on  hand. 

Other  quick  assets  (describe  fully) : 
Total  quick  assets  (excluding  all  in- 
vestments). 

Securities: 

25.  Securities  readily  marketable 
and  salable  without  impair- 
ing the  business. 
27.  Notes  given  by  officers,  stock- 
holders, or  employees. 
29.  Accounts  due   from   officers, 
stockholders,    or  employees. 
Total  current  assets. 

Fixed  assets: 

31.  Land  used  for  plant. 
33.  Buildings  used  for  plant. 
35.  Machinery. 

37.  Tools  and  plant  equipment. 
39.  Patterns  and  drawings. 
41.  Office  furniture  and  fixtures. 
43.  Other    fixed    assets,    if     any 
(describe  fully). 


Less: 
45. 


Reserves  for  depreciation. 
Total  fixed  assets. 


Deferred  charges: 

47.  Prepaid    expanses,    interest, 
insurance,  taxes,  etc. 

Other  assets  (49). 
Total  assets. 


LIABILITIES— Con/. 

Secured  liabilities — 
20a.  Notes       receivable       dis- 
counted or  sold  with  in- 
dorsement    or     guaranty 
(contra). 
20b.  Customers'    accounts    dis- 
counted or  assigned  (con- 
tra). 
20c.  Obligation  secured  by  liens 

on  inventories. 
20d.  Obligations  secured  by  se- 
curities deposited  as  colla- 
teral. 
22.  Accrued  liabilities  (interest, 
taxes,  wages,  etc.). 
Other   current   liabilities    (describe 
fully): 

Total  current  liabilities. 
Fixed  liabilities: 

24.  Mortgage     on     plant     (due 

date  ). 

26.  Mortgage  on  other  real  estate 

(due  date  ). 

28.  Chattel  mortgage  on  ma- 
chinery or  equipment  (due 
date  ). 

30.  Bonded  debt  (due  date         ). 
32.  Other    fixed    liabilities    (de- 
scribe fully): 

Total  liabilities. 

Net  worth: 

34.  If  a  corporation — 

(a)  Preferred  stock  (less  stock 

in  treasury). 
(6)  Common  stock  fless  stock 
in  treasury). 

(c)  Surplus      and      undivided 

profits. 
Less — 

(d)  Book  value  of  good  will. 
(f)  Deficit. 


[37] 


Complete  Balance  Sheet 

The  Montville  Manufacturing  Company 

Balance  Sheet,   December  31,  1919 


ASSETS. 

CAPITAL,  LIABILITIES,  AND  SURPLUS. 

Fixed  or  Capital  Assets. 

Capital  Stock. 

Plant  and  Property.  Schedule  1. 

Preferred: 

Investments.   Schedule  2. 

Authorized. 

Treasury  Stock  at  Par. 

Less — Unissued. 

Treasury  Bonds  at  Par. 

Issued  and  Outstanding. 

Patents. 

Common : 

Trademarks. 

Authorized. 

Goodwill. 

Less — Unissued. 

Working  and  Trading  Assets. 

Issued  and  Outstanding. 

Inventories,  Schedule  3. 

Capital  Stock  Subscribed. 

Current  Assets: 

First  Mort.  5%  Bonds. 

Cash.     Schedule  4. 

Authorized. 

Securities.    Schedule  5. 

Less — Unissued. 

Accounts  Receivable. 

Issued  and  Outstanding. 

Accrued      Interest      on      Bonds 

Five-year    6%    Notes   Issued 

and 

Owned. 

Outstanding. 

Dividends    Declared    on    Stocks 

Current  Liabilities: 

Owned. 

Taxes  Accrued. 

Drafts  and  Notes  Receivable. 

Payroll  Accrued. 

Interest  Accrued  on  Drafts  and 

Accounts  Payable. 

Notes  Receivable. 

Notes  and  Drafts  Payable. 

Due  from  Subscribers  to  Capital 

Expenses  Accrued. 

Stock. 

Interest  Accrued  on  Notes 

and 

Total  Current  Assets. 

Drafts  Payable. 

Sinking  Fund  for  Bonds. 

Dividends  Payable. 

Schedule  6. 

Interest  Accrued  on  First  Mort. 

Insurance  Fund. 

Bonds. 

Pension  Fund. 

Interest  Accrued    on    Five- Year 

Deferred  Assets.     Schedule  7. 

Notes. 
Total  Current  Liabilities. 
Reserves.     Schedule  7. 
Profit  and  Loss  Surplus. 
Capital  Surplus. 

Total 

Total 

Contingent    Liabilities    with 

par- 

ticulars. 

Schedules  Supporting  Balance  Sheet. 

1.     Plant  and  property: 
Land  and  buildinjjs. 
Additions  to  buildings. 
Plant  equipment. 
Horses,  wagons,  and  motors. 
Furniture  and  fixtures. 
2.     Investments: 

Securities  owned:  Names  and  amounts  of  stocks 

I  38] 


and  bonds   with  dividend  and   interest  yield, 
price  paid  and  present  market  price. 

3.  Inventories: 

Raw  Materials. 
Manufacturing  department. 
Finished  goods,  manufacturing. 
Finished  goods,  trading. 
Shipping  department. 
Coal,  oil,  and  waste. 
Stable  and  garage  supplies. 
Postage,  stationery,  &c. 

4.  Cash  in  hand  and  on  deposit: 

Cash  in  bank. 

Impressed  cash,  and  expense  fund. 

Freight  deposit. 

5.  Securities: 

See  Schedule  No.  2. 

6.  Sinking  Fund: 

See  Schedule  No.  2. 

7.  Deferred  charges  to  expense: 

Discount  on  bonds. 
Legal  expense  deferred. 
Organization  expense. 
Insurance  prepaid. 
Rent  paid  in  advance. 
Taxes  paid  in  advance. 
Advertising. 
Advances  for  subsidiaries: 

8.  Reserves  for: 

Depreciation,  Buildings,  Equipment,  etc. 

"  Outside  investments. 

"  Subsidiary  securities. 

"  Treasury  stock. 

*'  Treasury  bonds. 

"  Raw  materials. 

"  Current  asset  securities. 

"  Accounts  and  notes  receivable. 

"  Sinking  and  other  fund  securities. 

Extinguishment  of  assets. 
Dividends. 

[39] 


A  corporation  must  have  well  designed  and 
executed  accounting  control  in  order  that  it 
be  properly  managed  and  proper  report  given 
to  the  security  holders. 

Since  the  worth  of  a  security  is  in  effect  a 
reflection  of  the  credit  position  of  a  corpora- 
tion, the  Statement  Form  of  the  Federal 
Reserve  Bank  of  New  York  will  be  found 
highly  suggestive,  (Obtainable  direct.)  That 
this  form  is  not  complete  will  be  seen  in 
comparing  with  other  bank  forms.  See  fFally 
Bankers'  Credit  Manual,  57-134. 

2.     Certificates  of  Public  Accountants, 

Colhefy  71-74;  Tovey — Balance  Sheets, 
64-71. 

Uncertified  report,  whether  on  circular  or 
in  published  corporation  report,  like  an  un- 
searched  real  estate  title. 

Class  of  work  done  by  accountants  varies 
greatly — sometimes  done  to  suit  corporation 
officials. 

Acceptance    of    competitive    bidding    for 
audit  work  unwise  policy. 
Partial  audit. 

Accountants  should  in  their  certificate  as- 
sume wide  responsibility.  Accountants  as- 
sume no  responsibility  other  than  that  stated 
in  the  certificate  of  audit.  To  the  interest 
of  investor  to  read  the  auditor's  certificate 
concerning  figures  given  in  an  offering  of 
securities. 

[40] 


To  show  the  necessity  of  knowing  what  the 
accountant's  certificate  assumes,  a  recent 
balance  sheet  had  attached  a  certificate  stat- 
ing that  a  part  of  the  company's  inventories 
and  accounts  and  bills  payable  standing 
against  these  inventories  were  not  included 
in  the  statement.  Another  company  charged 
huge  losses  against  organization  expenses, 
adding  them  to  the  assets.  The  bare  balance 
sheets  would  not  have  disclosed  the  facts. 


[41] 


VIII 

Analysis  of  Balance-Sheet  Items.     Debit 

I. — Capital  Assets 

These  assets,  excluding  investments,  are 
often  combined  in  one  item:  Plant  and  Equip- 
ment. The  amount  may  simply  be  an  arbi- 
trary figure  offsetting  the  amount  of  stocks 
and  bonds  on  the  credit  side.  Often  largely 
"good  will"  or  "water."  Tangible  and 
intangible  assets  should  be  separated. 

Danger  in  issuing  securities  against  over- 
valued and  unserviceable  plants,  which  can- 
not compete  successfully  or  support  interest 
or  dividend-paying  securities. 

Depreciation,  including  obsolescence,  must 
be  provided  for.  General  methods  of  ac- 
counting depreciation.     Examples. 

Collver,  81-89;  Hatfield,  121-143;  Mead, 
190-198,  200-204;  Loughy  422-426;  Ger- 
stenberg — Principles,  706-711;  CoUy  95-115; 
Wildmaiiy  236-250;  Wall,  Bankers'^  Credit 
Manual,  227-232;  Saliers — Depreciation,  13- 
33>  39-72>   77-79.    121-188. 

Depreciation    should    be  provided    for  es- 

[42I 


pecially  well  on  property  bought  in  times  of 
inflation. 

Unless  capital  assets  be  well  maintained 
and  proper  depreciation  allowed  for,  it  would 
follow  that  the  maturity  of  long-term  bonds 
might  find  these  assets  of  little  value. 

Insurance:  Fire.  Is  enough  carried  and 
the  amount  changed  sufficiently  often  to 
cover  adequately  yet  economically  seasonal 
requirements?  Mistake  for  most  corpora- 
tions to  ** Carry  own  insurance." 

Insurance:  Use  and  Occupancy.  Insur- 
ance against  loss  of  business  until  destroyed 
property  can  be  replaced.  Modification  cov- 
ers only  actual  losses  and  fixed  charges  dur- 
ing such  a  period. 

Collver,  90-92. 

2.     Permanent  Investments 

Either  investments  made  out  of  surplus 
earnings  or  securities  of  subsidiary  or  affili- 
ated companies. 

Separate  schedules  of  all  outside  invest- 
ments with  prices  paid  and  other  particulars 
should  be  given.  Analysis  item  by  item  nec- 
essary.    Special  reserve  usually  necessary. 

Possibilities  of  concealment  and  fraud  be- 
tween books  of  a  holding  company  and  sub- 
sidiary almost  unlimited. 

Collver,  93-96. 

Separate  and  consolidated  accounts  neces- 

[43I 


sary  in  case  Permanent  Investment  account 
is  important  and  consists  principally  of  sub- 
sidiary securities. 

Collver,  96;  WildmaUy  296-301. 

For  unusually  frank  report  on  permanent 
investments  of  an  industria^l,  see  Gerstenherg 
— Materials,  627-662. 

Treasury  Stocks  and  Bonds. 

Colher,  97-98;  Wildmany  116-117. 

Treasury  securities  are  presumed  to  have 
been  issued  for  full  value — can  be  disposed  of 
as  desired. 

Unless  actually  worth  par  in  the  market, 
should  have  a  reserve  as  offset  to  discount  in 
value. 

Good  Will. 

Colher,  99-102;  Lyon  I,  83-107;  Lough, 
179-189;  Cooper,  184-252;  Hatfield,  107- 
118  (Including:  other  immaterial  assets). 

See  also  X.     Page  67. 

Good-will  account  is  a  capitalization  of  the 
profit  resulting  from  business  secured  and 
therefore  logically  to  be  expected  in  the  fu- 
ture. However,  a  good-will  account  may  be 
simply  an  arbitrary  figure. 

Usually  is  given  separately  if  at  all  unless 
there  is  necessity  for  concealing  the  actual 
value  of  the  account  with  which  good  will  is 
included. 

[44] 


Firms  having  the  largest  bona-fide  good  will 
often  do  not  capitalize  it  on  the  books  at  all. 

Good-will  account  often  arises  in  recapital- 
ization of  corporation  with  common  stock 
representing  good  will. 

Good  will  may  simply  be  capitaHzation  of 
harmony  of  previously  opposed  interests. 

May  represent  advertising. 

Usually  considered  an  asset  of  diminishing 
value  and  should  be  reduced  year  to  year  by 
setting  aside  surplus  earnings  directly  or  by 
adding  to  the  final  profit  and  loss  surplus. 

For  decisions  in  re  Good-will  see  Gersten- 
berg — Materials,  1019-1021. 

5.     Patents^  Trademarks^  and  Brands. 

Collvery  103-107;  Jordan,  181;  Cooper, 
1 18-148;  /Ffl//— Bankers'  Credit  Manual  231- 
232;  Lough,  426. 

May  be  legitimate  accounts,  but  may  be 
arbitrary  amount  of  Good  will  or  "Water." 

Basic  patents  of  the  most  value.  Examples 
of  especially  valuable  patents. 

Patents  many  times  do  not  protect  against 
infringement — often  are  simply  a  license  to 
engage  in  lengthy,  expensive  litigation. 

Patents  a  wasting  asset — must  be  written 
off  during  their  life. 

Patent  may  create  valuable  good  will. 

Trademarks  and  brands  may  have  ma- 
terial and  lasting  value. 

[45] 


Patents,  trademarks,  and  brands  should  be 
protected  in  foreign  countries  well  in  advance 
of  active  preparations  to  invade  foreign  mar- 
kets. 

6.     Working  and  Trading  Assets. 

Collver,  109-113;  Gerstenherg — Principles, 
733-734;  Wildman,  1 18-125. 

Consist  of  inventory  items  of  all  kinds  from 
postage  stamps  to  finished  goods:  materials 
used  in  the  conduct  of  the  business,  or  manu- 
facture of  goods.  Account  is  called  **  Work- 
ing Assets"  in  case  of  purely  manufacturing 
concern;  "Trading  Assets"  in  case  of  a  mer- 
cantile corporation. 

Working  and  Trading  Assets  should  be 
separately  stated,  but  are  sometimes  included 
among  Current  Assets  (see  following  page). 
Working  and  Trading  Assets  cannot  usually  be 
turned  in  to  cash  immediately. 

Correct  inventory  must  be  assured  both  as 
to  quantity  and  value. 

Prices  should  be  at  cost  with  a  reserve  cre- 
ated if  prices  decline  from  cost.  Usually 
valued  at  "cost  or  market  value,  whichever 
is  lower." 

Prices  should  not  be  marked  up  on  balance- 
sheet  accounts  if  inventory  values  advance, 
but  when  bought  at  abnormally  high  prices, 
ample  reserves  should  be  provided. 

Goods  in  process  valuation. 

[46] 


Finished  goods  valuation. 

Value  of  inventories  in  relation  to  their 
nearness  to  raw  material  form. 

Relation  of  inventories  to  discounts. 

Comphcations  which  may  possibly  arise  in 
regard  to  holding  companies  and  subsidiaries. 

Current  Assets. 

Collver,  1 1 5-1 17;  Gerstenherrg — Principles, 
730-733;  Wildman,  126-133. 

Accounts  should  include  only  items  which 
will  soon  become  available  in  cash. 

Each  item,  e.g.,  cash,  should  be  given  sepa- 
rately. Possibility  of  misstatement  in  item 
so  apparently  simple  as  "Cash  and  Cash 
Items."     See  CoUy  118. 

Relative  status  of  Accounts  and  Notes 
Receivable. 

Drafts,  Notes,  or  Temporary  Investments. 

Schedules  of  securities  should  be  given  and 
basis  of  valuation.  Should  be  highly  mar- 
ketable. Preferable  valuation  is  at  cost 
with  reserve  for  depreciation  if  any. 

Interest  accrued  on  obligations  and  divi- 
dends declared. 

Holding  company  status  in  regard  to  Cur- 
rent Assets  can  be  shown  definitely  only  by 
having  the  accounts  of  the  holding  company 
and  subsidiaries  separately  and  also  a  consoli- 
dated balance  sheet  with  inter-company  ac- 
counts eliminated. 

[47] 


8.     Sinking,  Insurance^  and  Other  Special  Funds. 
Collvcr,   I19-121;  Lough,  161-171. 

Sinking  funds  are  accumulations  of  capital: 
specific  assets,  set  aside  to  meet  or  to  antici- 
pate obligations  maturing  in  the  future  or  to 
retire  preferred  stock.  May  be  in  cash  or 
securities. 

Possible  danger  if  accumulated  in  cash  in 
company's  treasury. 

If  in  cash,  location  and  control  should  be 
known. 

If  in  securities,  a  schedule  should  be  given, 
with  purchase  price  and  present  value — with 
offset  reserve  for  depreciation  if  any. 

Provision  that  sinking-fund  payments  be 
made  to  a  trustee,  which  each  year  will  use 
the  payments  in  retiring  securities  by  purchase 
or  call  at  redemption  price— the  securities 
then  to  be  destroyed.  Purchased  bonds 
sometimes  "kept  alive"  and  interest  paid  on 
them. 

Method  of  the  United  States  Steel  Cor- 
poration. 

Insurance  Fund.  Should  be  in  cash  or 
marketable  securities.  If  latter,  schedules, 
etc.,  should  be  provided  for  as  with  Sinking 
Fund  assets.  See  also  Collver,  90-91,  re 
insurance. 

Special  Funds.  These  may  be  accumu- 
lated and  set  aside,  e.g.,  invested  in  securities 
for  some  special  purpose  such  as  for  the  equal- 

I  48] 


ization  of  dividends.  Not  usually  a  good 
policy.  Dividend  Fund  seldom  yields  enough 
to  make  it  worth  while,  and  investments  may 
depreciate.     Loughy  475-477. 

See  IX,  8.  Pages  62-63  iri  re  Reserves.  See 
JVildmaUy  184-192;  Lough,  465-466,  and  Sa- 
liers — Depreciation,  49-59  in  re  relation  of 
funds  to  reserves. 

9.     Deferred  Assets. 

Collver,  123-126,  155;  Gerstenherg — Prin- 
ples,  735-736;  /iTzY^maw,  153-158. 

Usually  neither  current  nor  capital  assets. 
Part  are  largely  "assets  by  courtesy." 

Prepaid  Insurance — how  handled  on  books. 

Organization,  Legal,  or  Moving  Expense 
to  be  written  off  as  soon  as  possible.  Such 
items  may  be  very  large — sometimes  hidden 
under  one  more  or  less  ambiguous  term. 

Unusual  advertising  often  included  among 
deferred  assets. 

Advances  to  subsidiaries  for  expansion 
should  be  among  Deferred  Assets. 

Discounts  on  Securities  sold  should  be  con- 
sidered a  deferred  "asset"  and  written  off. 

Consideration  of  prepaid  items  as  Current 
Assets.     Colher,  155. 


[49] 


IX 

Analysis  of  Balance-Sheet  Items.     Credit 

I.     Bonds. 

C  Oliver,  127-136. 

(A.)     General  Consideration. 

In  early  days  of  combinations,  bonds  were 
issued  not  only  to  the  amount  of  the  proper- 
ties but  also  for  promoters'  profits,  making  a 
fixed  charge  of  expected  economies. 

Moreover,  bonds  were  issued  on  the  basis 
of  expected  earnings  in  years  of  greatest  pros- 
perity, later  causing  the  loss  of  hundreds  of 
millions  of  dollars. 

Few  large  corporations  have  too  large 
bond  issues  to-day.  Both  financiers  and 
investors  have  learned  much  by  experience. 

If  a  business  is  one  having  a  steady  income, 
bonds  can  safely  be  issued  as  a  means  of 
"trading  on  the  equity."  Advantage  to  the 
stockholders  of  "trading  on  the  equity." 

See  Lyo7i  I,  50-82. 

The  maximum  size  of  bond  issues  should 
be  determined  by  what  can  be  earned  with  a 

[50] 


liberal  margin  in  depressed  times,  as  the 
bondholders  hold  the  ''mortgage  on  the 
farm." 

The  solvency  of  a  corporation  depends 
upon  the  form  of  capitalization  and  not  the 
amount.  Stock  can  be  issued  to  any  amount 
and  in  time  of  poor  earnings,  holders  simply 
be  told  to  wait. 

Industrials  should  borrow  money  sparingly 
as  a  general  rule.  Earnings  often  fluctuate 
widely,  and  in  the  case  of  insolvency  the 
plants  may  be  of  little  value  because  of 
changes  in  demand  for  many  lines. 

Expansion  as  far  as  possible  should  be  fi- 
nanced through  earnings,  or  stock  issue,  es- 
pecially in  times  of  prosperity,  as  plant  assets 
are  apt  to  prove  only  a  burden  in  times  of 
depression.  The  customary  business  depres- 
sion cuts  oflp  about  50  per  cent,  of  the  average 
industrial's  income  available  for  interest. 
Net  earnings  for  each  of  the  past  five  years 
should  be  at  least  double  the  total  interest 
charges  of  all  fixed  obligations.  Further  cap- 
ital requirements  could  well  be  met  from 
profits  and  increased  capital  stock.  See  Jor- 
dan, 109. 

(B.)     Bond  Provisions. 

Security  underwriters  have  wisely  insisted 
upon  limitation  to  the  size  of  issues  and  have 
written  into  the  indentures  provisions  that 
serve  to  protect  the  corporation  against  over- 

[Sil 


ambition    in    expansion    and    to   protect   di- 
rectly the  investor's  funds. 

Typical  provisions  are  that: 

The  unincumbered  quick  assets  of  the 
company  and  subsidiaries  shall  at  all  times 
exceed  the  aggregate  debt  of  the  company 
and  subsidiaries,  "Including  the  outstanding 
bonds  of  this  issue." 

"That  the  liquid  assets  of  the  company  must 
equal  the  aggregate  debts,  including  outstand- 
ing bonds  of  this  issue."  In  such  cases  quick 
or  liquid  assets  usually  include  inventories. 

Collver,  133-134;  Mead,  71. 

Proportion  to  assets.     Lough,  143-145. 

Sinking  Funds  are  often  required  to  meet 
or  anticipate  obligations. 

See  VIII,  Page  48. 

Usually  the  sinking  fund  provides  for  a 
certain  amount  to  be  set  aside  each  year. 
A  more  flexible  plan,  and  better  adapted  to 
corporations  which  may  have  rather  widely 
fluctuating  earnings,  provides  for  a  certain 
percentage  of  earnings  available  for  dividends 
set  aside. 

Many  bond  issues  have  a  redeemable  or 
callable  figure  usually  at  a  price  above  par — • 
say  at  105  or  1 10  in  case  of  long-term  issues, 
so  that  the  outstanding  obligations  may  be 
called  in  in  case  conditions  make  such  ac- 
tion advisable. 

Amortization.     Lyon,  I,  144-165. 

[52] 


(C).     Convertible  Bonds. 

Collver,  144-145;  Gerstenherg — Materials, 
324;  Jordan,  26-27,  301-302;  Annals — 
Moody,  77-78. 

A  method  of  providing  for  the  eventual 
replacement  of  the  bonds  by  stocks,  and  often 
used  at  times  when  conditions  are  unfavor- 
able to  the  issue  of  common  stocks  is  the  is- 
suance of  bonds  convertible  into  stock — 
nearly  always  into  common  stock,  but  oc- 
casionally, as  in  the  case  of  the  Western 
Electric  7s,  into  preferred  stock. 

The  convertible  bond  holds  its  price  as  a 
fixed  obligation,  and  enjoys  an  increase  in 
value  if  the  stock  advances  above  the  conver- 
sion figure  later  on. 

Example:  convertible  6  per  cent,  bond  pur- 
chased at  90  convertible  into  common  stock 
at  75  while  stock  is  selling  at  60.  To  the 
purchaser  of  the  convertible  bond  at  90 
the  stock  has  but  to  advance  above  67.50 
before  the  bond  can  be  converted  at  a  profit. 
The  price  paid  for  the  bond  in  percentages 
is  multiplied  by  the  conversion  price  for  the 
stock,  i.e.,  90  X  75 — 67.50.  Since  the  in- 
vestor pays  a  certain  percentage  for  his  bond, 
below  or  above  par,  the  stock  should  sell  at 
the  same  percentage  of  the  conversion  price 
to  establish  the  profitable  conversion  point. 
As  a  matter  of  fact,  the  investor  does  not  have 
to  convert  to  obtain  his  profit,  because  as  the 
stock  advances,  the  bond   also  increases  in 

[S3] 


price,  and  the  bond  holder  can  simply  sell  his 
bond  at  a  profit. 

Prospective  convertible  bond  holders  should 
see,  however,  that  the  speculative  possibility 
of  the  issue  he  is  considering  is  not  limited 
by  a  privilege  of  the  company  to  retire  the 
bonds  at  a  figure  close  to  the  price  he  pays. 

Example.  For  examples  of  convertible  pro- 
visions of  a  bond  see  Gerstenherg — Materials, 
322-323. 

2.     Short-Term  Notes. 
Collver,  134-136. 

Obhgations  coming  due  within  five  years 
are  usually  called  notes,  whether  or  not  se- 
cured. They  are  issued  either  to  carry  tem- 
porary needs,  or  to  avoid  going  into  the  long- 
time bond  market  at  an  unfavorable  time, 
planning  in  the  latter  case  to  refund  at  a 
more  propitious  season.  Skill  or  good  for- 
tune must  attend  refunding,  including  long- 
term  bonds  approaching  maturity,  for  they 
are  in  effect  short-term  notes,  because  when 
near  maturing  obligations  actually  mature, 
conditions  for  refunding  may  or  may  not 
be  favorable.  Example  of  unfortunate  ma- 
turity. Good  managers  plan  refunding  far 
ahead  and  conservative  corporations  which 
have  strong  financial  backing  have  seldom, 
if  ever,  defaulted  through  inability  to  secure 
funds. 

Short-term    notes    nearly    always   have   a 

[54] 


callable  provision  in  order  that  the  corporation 
may  redeem  the  notes,  or  refund  them  at  an 
advantageous  time  into  long-term  securities. 

Many  funded  debt  securities,  usually  short- 
term  notes  but  sometimes  including  long- 
term  obligations,  are  issued  in  serial  form, 
i.e.,  a  certain  amount  coming  due  annually. 
This  may  be  a  good  plan,  obviating  the  com- 
plications of  a  sinking  fund  or  other  special 
measures  for  redemption,  but  care  must  be 
taken  that  not  too  large  an  amount  come  due 
any  one  year,  so  that  the  arbitrary  maturity 
may  not  be  too  large  in  a  possible  year  of  de- 
creased profits,  as  serial  maturities  must  in 
most  cases  be  taken  care  of  from  earnings. 

See  Mead,  89-90. 

3.     Preferred  Stocks. 

C Oliver,  1 37-141. 

Following  a  recognition  that  excessive 
bond  issues  were  dangerous,  a  multitude  of 
corporations  were  financed  by  selling  cumu- 
lative preferred  stocks  and  common,  and  no 
bonds.  The  preferred  was  supposed  to  repre- 
sent the  property  value.  Sometimes  not 
even  the  preferred  was  covered  by  assets. 
Several  large  corporations  succumbed  be- 
cause of  paying  unearned  dividends  on  exces- 
sive amounts  of  preferred  stocks,  in  order 
to  give  promise  of  dividends  on  the  common. 
Such  practices  are  seldom  undertaken  nowa- 
days. The  amounts  of  preferred  are  hedged 
in  by  special  provisions. 

[55] 


The  dividend  on  a  preferred  issue  may  de- 
pend upon  the  provisions  of  any  bonds  or 
notes  outstanding,  i.e.,  provisions  of  the  senior 
securities  may  call  for  setting  aside  of  a 
certain  amount  or  proportion  of  earnings — or 
may  provide  for  the  maintenance  of  a  cer- 
tain fixed  or  determinable  surplus.  Divi- 
dends on  the  preferred  stock  might  be 
passed  in  order  that  the  requirements  of  the 
senior  securities  be  provided  for  fully. 

As  a  rule  it  will  be  found  that  the  aggregate 
market  value  of  common  stocks  junior  to 
seasoned  preferred  issues  is  large,  i.e.,  the 
market  equity  for  the  preferred  is  large. 
Perhaps,  however,  the  common  stock  may 
sell  very  high  and  yet  the  preferred  not 
rank  high.  The  reason  for  this  would  be  that 
the  common  would  be  highly  speculative,  and 
purchasers  bought  it  with  the  idea  of  huge 
potential  earnings,  while,  since  only  investors 
would  buy  the  preferred,  this  issue  would  not 
be  attractive,  owing  to  the  lack  of  proved 
earning  power. 

For  special  provisions,  which  safeguard 
and  set  standards  for  preferred  issues,  see  V 
(Provisions  of  Preferred  Stocks),  Pages  8-23. 

Common  Stock. 

(A.)  Industrial  Common  Stocks  Are  Seldom 
to  Be  Cofisidered  as  Investinent  Securities. 
Earnings  and  dividends  usually  fluctuate 
widely.     In  some  cases,  however,  after  years 

[56] 


of  conservative  policy,  regular  dividends  have 
become  fully  as  safe  as  on  a  good  part  of  the 
preferred  issues.  Usually  investment  com- 
mon stocks  yield  moderately  on  the  market 
price  since  their  speculative  possibilities  in 
giving  out  extra  dividends,  rights,  or  increas- 
ing the  dividend  are  reflected  in  the  quo- 
tations. On  the  other  hand,  high-grade  in- 
vestment preferred  stocks,  long  and  short 
term  bonds  reflect  the  value  of  money — in- 
terest rates. 

The  dividend  position  of  a  common  stock 
may  depend  upon  the  provisions  of  the  pre- 
ferred issue  or  issues,  and  upon  the  provisions 
of  any  bonds  or  notes  outstanding,  i.e.,  pro- 
visions of  the  senior  securities  may  call  for 
setting  aside  of  a  certain  amount  or  pro- 
portion of  earnings — or  may  provide  for 
the  maintenance  of  a  certain  fixed  or  deter- 
minable surplus.  Dividends  on  the  common 
stock  might  be  passed  for  a  time  in  order  that 
the  requirements  of  the  senior  securities  be 
provided  for  fully. 

For  diff'erent  forms  of  common  stocks  see 
II,  2  Pages  6-7. 

For  legality  of  issue  of  stock  see  Hatfield^ 
144-183. 
(B.)     Changing  Capitalization  Form.    Rights. 

Collvevy  143. 

As  corporations  are  able,  they  usually  re- 
tire the  bond  issues  through  either  call  at  the 
redeemable    figure   or   through    purchase    in 

[57I 


the  open  market.  Such  operation  has  several 
benefits — reduces  the  interest  on  capital  re- 
quirements of  the  company — maintains  the 
market  value  of  the  bonds — makes  even 
stronger  the  position  of  the  bonds  not  yet  re- 
tired. Reduces  the  inconvenience  of  having  a 
bond  issue  to  refund  at  maturity.    Example. 

Financing  through  issue  of  common  stocks. 

Collver,  144.     Lyon  II;  15-34. 

When  common  stocks  with  established 
earnings  are  selling  well  above  par  in  a  favor- 
able general  market,  corporations  often  prefer 
to  issue  common  stock  to  the  holders  of  that 
already  outstanding  than  to  issue  other  forms 
of  capitalization  as  payments  on  common 
stocks  are  optional.  If  the  market  price  is 
low  or  general  market  conditions  especially 
unfavorable  the  issue  of  new  stock  might  not 
be  successful  and  injure  the  credit  of  the  com- 
pany. It  is  now  customary  to  have  new 
stock  offerings  underwritten  by  strong  in- 
vestment bankers,  who  usually  syndicate  the 
liability  assumed. 

For  mathematics  of  rights  see /or^aw,  21-22. 

Rights  are  also  given  common  stockholders 
in  many  instances  to  acquire  preferred  stocks 
and  bonds  at  favorable  figures.  Example: 
right  to  subscribe  to  Standard  Oil  of  New 
Jersey  Preferred  at  par  in  1920. 

For  form  of  right  to  subscribe  to  preferred 
stock  see  Gerstenberg — Materials,  1017-1018. 

5.     Current  Liabilities. 

[58] 


Collver,    147-151;    Knifin,    454-457;    460. 

Include  unfunded  corporate  obligations 
which  will  soon  be  payable.  Technically  do 
not  include  bonds  or  notes  soon  maturing — 
actually  do  include  such  items.  Include 
actually  items  such  as  taxes  accrued,  but  not 
paid  at  the  date  the  balance  sheet  is  made  up. 
Wages  Accrued,  Interest  Accrued  on  Notes 
and  Drafts  Payable,  Interest  Accrued  on 
Bonds  and  Notes  Payable,  Dividends  de- 
clared but  not  paid,  and  Expenses  Accrued 
should  be  given  separately  and  under  the 
Current  Liability  head. 

Accounts  and  Notes  Payable  should  be  given 
separately.  Accounts  payable  represent  sup- 
plies, while  Notes  Payable,  including  Bills  and 
Drafts,  may  represent  accounts  that  the  cor- 
poration could  not  meet  promptly  or  a  multi- 
tude of  other  purposes  that  require  special 
explanation.  Seasonal  businesses  are  gener- 
ally financed  by  notes  discounted  at  banks. 

Notes  Payable,  known  as  commercial  paper 
have  normally  a  ready  sale  in  the  market. 
Possibility  of  over-extension  through  increase 
in  amount  of  commercial  paper.  Regis- 
tration of  commercial  paper.  See  also  Ger- 
stenherg — Materials,  907-908. 

Advantage  in  analyzing  if  bank  loans  are 
separated  from  ordinary  trade  obligations. 
If  assets  are  pledged  for  loans,  particulars 
should  be  given.  See  Tovey — Balance  Sheets, 
36-38., 

[S9l 


Contingent  Liabilities.  This  item  is  not 
an  absolute  liability  and  should  appear  in 
case  contingent  liability  exists,  as  a  footnote 
to  the  balance  sheet.  May  be  an  important 
and  even  dangerous  item. 

Working  Capital. 

Collver,  153-156. 

Working  Capital  or  Net  Current  Assets 
are  the  net  free  quick  assets  of  a  corporation. 
Not  usually  given  on  a  balance  sheet.  Found 
by  subtracting  current  liabilities  from  cur- 
rent assets. 

Most  industrials  require  a  large  amount, 
dependent  upon  the  nature  of  the  enterprise. 
Certain  lines  of  industrials  require  little 
working  capital. 

Technically,  Net  Current  Assets  do  not 
include  any  Inventory  Account,  but  generL-l 
practice  is  to  include  them.  Exarnple  of  us- 
ual Current  Assets,  Current  Liabilities,  and 
Net  Working  Capital.  Possibility  that  cur- 
rent liability  items  be  concealed  among  long- 
term  obligations. 

Net  Working  Capital  should  normally  in- 
crease. Certainly  it  should  not  be  decreased 
except  for  good  cause. 

Technical  Net  Quick  Assets  should  be 
v^^orked  out  for  several  years  back  from  bal- 
ance sheets,  omitting  Inventories.  The  Net 
Working  Capital,  including  Inventories,  may 
show  a  splendid  increase  from  year  to  year, 

[60I 


but  if  this  increase  is  accounted  for  in  a 
rapid  increase  in  inventories,  the  situation 
may  be  dangerous,  owing  to  a  possibility  of 
loss  in  the  value  of  the  goods. 

Floating  Debt:  an  excess  of  current  liabili- 
ties over  current  assets.  Usually  a  dan- 
gerous condition,  especially  if  inventory 
accounts  have  been  considered  among  cur- 
rent assets. 

Working  Capital  position  is  the  first  test 
of  an  industrial's  condition  made  by  bankers, 
investment  dealers,  and  careful  investors. 

See  Jordan,  351;  Lough,  361-363;  Ger- 
stenberg — Principles,  127-132, 

Comparison,  however,  must  be  made  of 
balance  sheets  of  the  same  seasons  of  the 
year,  as  most  industrials  are  seasonal  in 
working  capital  requirements. 

Amount  of  working  capital  required  deter- 
mined by: 

a.  Size  of  corporation. 

b.  Variety  of  products. 

c.  Whether  company  is  expanding 
rapidly. 

d.  Whether  it  takes  a  long  or  short  time 
for  goods  to  be  manufactured, 

e.  The  extent  the  business  is  sea- 
sonal, seasonal  business  requiring  large 
amount. 

f.  The  quickness  of  turnover,  slow  turn- 
overs requiring  large  amount. 

[61] 


g.  Terms  of  credit  extended — the  longer 

the  terms  the  more  capital  required. 

h.  Longer    terms    company    can    obtain 

in  purchasing  the  less  capital  required. 

i.  Difficulty  in  securing  raw  materials — 

if  great,  must  anticipate  requirements 

and  pay  for  much  stock  far  in  advance. 

Suggested    method    of    estimating    initial 

working   capital    requirements.     See    Lough, 

380-414,  502-507. 

7.     Reserves. 

Collver,  157-158.  Saliers — Financial  State- 
ments, 57,  62-78. 

Wildmariy  174-183;  Lough,  426-427. 

Necessity  of  adequate  reserve  already  taken 
up  in  consideration  of  Fixed  or  Capital  As- 
sets.    VIII.  I.  Pages  42-43. 

Permanent  Investments  VIII.  2.  Pages;  43- 
44. 

Working  and  Trading  Assets  VIII.  6.  Pages 
46-47;   and    Current   Assets   VIII.  7.     Page 

47- 

Reserves,  besides  those  for  depreciation  of 
buildings,  equipment,  securities,  materials, 
and  receivables,  may  be  provided  for  special 
purposes,  e.g.,  relining  blast  furnaces,  and 
for  the  exhaustion  of  ass.ets  such  as  coal  or 
ore,  and  even  for  setting  aside  profits  for 
sinking  funds. 

Reserves  are  not  funds — reserves  are  not 
[62I 


represented  in  cash,  securities,  or  other  definite 
assets.  They  are  amounts  taken  from  profits 
and  placed  on  the  liability  side.  The  amount 
of  the  reserves  is  represented  in  the  total  of  the 
assets.  The  amount  credited  to  the  re- 
serves cuts  down  the  amount  of  profits  which 
can  be  distributed  as  dividends. 

Yet  a  reserve  may  specifically  be  created 
to  provide  for  regular  dividends.  Little  is 
gained  by  such  provision,  since  the  entire 
Profit  and  Loss  Surplus  can  be  considered  as  a 
reserve  for  dividends.  See  IX.  9.  Pages 
63-65.  A  company  may  have  any  amount  of 
reserves  set  aside  for  dividends,  yet  it  must  be 
remembered  that  the  immediate  source  of  divi- 
dends is  net  current  assets — particula'rly  cash. 

Secret  Reserves.  Gerstenherg — Principles, 
751-752;  Hatfield,  254-255;  Lough,  479-481. 

Secret  Reserves  are  really  an  understate- 
ment of  the  final  surplus — caused  by  (a) 
Providing  too  liberally  for  depreciation;  (b) 
Excessive  provision  for  bad  debts;  (c)  Charg- 
ing capital  items  to  expense  accounts;  (d) 
Omitting  or  undervaluing  assets.  Secret  re- 
serves are  of  course  a  source  of  strength,  but 
deceive  stockholders. 

See  also  Sinking,  Insurance,  and  Special 
Funds.     VIII.  8.     Pages  48-49. 

8.     Surplus. 

Lough,  466-475 ;  Gerstenherg — Principles, 
161-164;  Saliers — Financial  Statements,  79- 
87. 

[63] 


Quoting  Collver,  1 59-160: 

"Profit  and  Loss  Surplus  is  not  a  tangible 
account  any  more  than  the  reserves.  Though 
originating  as  undivided  profits,  the  "Profit 
and  Loss  Surplus  will  be  found  to  be  simply 
the  remainder  after  subtracting  the  liabilities 
and  the  capital  stock  from  the  assets.  It 
evidences  the  amounts  of  assets  above  liabili- 
ties belonging  to  the  stockholders  aside  from 
and  added  to  the  par  value  of  the  stock. 

"The  surplus  is  real  only  if  the  assets  are 
real,  and  if  the  liabilities  are  correctly  stated. 
If  a  corporation  has  $1,000,000  worthless 
'Good  will'  among  its  assets  and  $500,000 
nominal  Profit  and  Loss  Surplus,  no  actual 
Surplus  exists,  but  instead  a  true  deficit  of 
$500,000, 

"Even  when  the  book  Surplus  is  entirely 
bona  fide,  it  is  seldom  available  in  cash  assets. 
The  Profit  and  Loss  Surplus  is  simply  an  ac- 
count of  profits  not  used  for  dividends,  but 
these  profits  usually  have  been  used  in  the  cor- 
poration's business.  The  surplus  may  be 
represented  in  materials,  in  machinery,  in 
plant,  or  in  part  of  any  number  of  assets.  It 
is  quite  possible  for  a  corporation  to  have  a 
splendid  surplus  in  fixed  assets,  and  yet  be 
hard  pressed  for  ready  cash.  Hence,  while 
surplus  is  decreased  by  the  cash  expended  in 
dividends,  yet  'paying  dividends  out  of 
surplus'  is  scarcely  a  statement  of  fact.  Cash 
dividends  are  of  course  payable  only  in  cash. 

[64I 


Financial  strength  usually  depends  more 
upon  the  amount  of  free  working  capital 
assets  than  upon  the  amount  of  nominal 
surplus. 

"Capital  Surplus  is  an  account  similar  to 
Profit  and  Loss  Surplus,  but  created  in  quite  a 
different  manner.  Suppose  10,000  shares  of 
stock  are  sold  at  150  or  ^1,000,000  par  value 
sold  for  $1,500,000.  The  difference  of 
$500,000  is  not  to  be  credited  to  Profit  and 
Loss  Surplus  because  it  is  not  considered  an 
earned  profit  account,  but  a  separate  Capital 
Surplus  account. 

"Many  Balance  Sheets  do  not  show  Profit 
and  Loss  Surplus  separately  from  Capital 
Surplus,  but  show  the  mixed  account  as  sim- 
ply 'Surplus.'  Part  of  the  Surplus  item 
of  one  of  the  largest  industrials  originated 
from  an  exchange  of  securities.  Second  pre- 
ferred 6  per  cent,  stock  was  exchanged  for 
first  preferred  8  per  cent,  stock  at  four  shares 
of  the  6  per  cent,  for  three  of  the  8  per  cent, 
stock.  The  actual  dividend  requirement  re- 
mained the  same.  However,  the  capital 
stock  amount  was  reduced  and  the  company 
exhibited  the  difference  as  an  addition  to  the 
Surplus.  No  deception  was  intended,  and 
the  transaction  was  explained  in  the  annual 
reports,  but  an  examination  of  the  balance 
sheet  alone  leads  many  people  to  believe  the 
large  'Surplus'  represents  only  profits  con- 
served from  the  business." 

[65] 


X 

Book  Value 

Collver,  161-163.  Jordan^  119-121.  Tovey — 
Balance  Sheets,  61-63.    See  also  Collver,  89,  90. 

Book  Value  is  the  theoretical  asset  value  of 
stock  derived  from  a  balance  sheet  and  with  no 
direct  consideration  of  earning  power. 

Method  of  obtaining  book  value  of  common 
stock: 

Subtract  the  liabilities,  including  reserves 
and  of  course  all  fixed  obligations,  and  the  pre- 
ferred stock  from  the  assets.  Divide  the  re- 
mainder by  the  number  of  common  shares  out- 
standing. 

Short  method,  and  proof  of  the  foregoing 
methods  if  the  common  stock  has  a  par  value: 
Add  the  total  common  stock  par  value  to  the 
surplus.  Divide  by  the  total  number  of  shares 
of  common.  This  rule  holds  even  in  case  of  no 
par  value  stock.  No  par  value  stock  may  sepa- 
rately be  credited  with  value  or  may  be  valued 
with  surplus  in  one  account. 

Method  of  obtaining  book  value  of  pre- 
ferred stock: 

[66] 


Subtract  the  liabilities,  including  all  fixed 
obligations,  from  the  assets.  Divide  the  re- 
mainder by  the  number  of  preferred  shares  out- 
standing. 

Short  method  and  proof  of  the  foregoing: 
Add  the  total  amount  of  the  common  par  value 
and  the  total  amount  of  the  preferred  to  the 
surplus.  Divide  by  the  total  number  of  shares 
of  preferred  outstanding. 

Calculation  of  book  value,  hke  that  of  Surplus, 
is  exact  to  the  extent  that  the  accounts  on  the 
Balance  Sheet  are  accurate.  If  there  is  more 
"Good-will"  than  there  is  remainder  after  sub- 
tracting liabilities  and  preferred  stocks  from  the 
assets,  the  common  will  have  no  tangible  book 
value  at  all,  and  if  there  is  a  preferred  issue  the 
preferred  may  not  be  represented  by  tangible 
book  value  to  the  extent  of  lOO  per  cent.  par. 
Therefore,  analysts  strike  out  from  the  assets 
any  dubious  accounts  before  attempting  to  work 
out  the  book  value.  It  is  quite  the  usual  pro- 
cedure to  make  the  Good-will  item  large  enough 
so  that  the  common  stock  will  appear  to  be 
covered  entirely  by  assets. 

The  book  value  is  at  best  usually  only  of  real 
service  if  the  assets  are  of  a  salable  nature  or 
backed  by  good  earning  power.  For  instance, 
the  preferred  stock  of  one  large  company — later 
reorganized  and  now  prosperous — had  actual 
assets  of  more  than  a  hundred  dollars  a  share 
back  of  it  while  the  stock  sold  for  the  nominal 
cost  of  brokerage.     The  assets  could  not  be 

[67I 


sold  to  advantage  and  the  company  was  losing 
money. 

As  indicating  how  differences  in  valuing 
property  affect  the  book  value,  consider  some 
of  the  steel  corporations  which  have  large  hold- 
ings of  iron  ore  lands.  Great  difference  of  opin- 
ion exists  in  regard  to  the  value  of  this  ore, 
even  of  that  which  is  ** proven."  The  book 
value  of  several  steel  companies  could  be  multi- 
plied several  times  simply  by  placing  a  higher 
but  apparently  reasonable  value  on  the  ore 
properties. 

However,  any  such  procedure  would  not  add 
to  the  market  value  of  the  stocks.  The  prices 
of  the  common  stocks  are  mostly  based  upon 
earnings,  past,  present,  and  prospective,  and  divi- 
dends past,  present,  and  prospective.  Value  of 
assets,  particularly  "natural  resource  assets" 
such  as  ore  and  lumber,  are  usually  of  value  to 
an  industrial  only  as  these  assets  can  be  turned 
into  finished  product,  the  finished  product  sold, 
and  profits  realized. 

To  take  a  skeletonized  balance  sheet: 

ASSETS  CAPITAL,  LIABILITIES,  AND  SURPLUS 

Fixed  Assets $11,000,000      Capital  Stock 

Working  Assets 13,000,000         •Common  50,000  sh.  5.000,000 

Current  Assets 15,000,000          Preferred  Par  $100  6,000,000 

Sinking     and      other                              First  6%  bonds 10,000,000 

funds 2,000,000      Current  Liabilities.  .  .  14,000,000 

Reserves 1,000,000 


$41,000,000 


Surplus 5,000,000 

$41,000,000 


•Par  value — Declared  value  in  the  case  of  no  par  value  stock. 

[68] 


To  find  the  book  value  of  the  common  stock 
subtract  the  current  HabiHties,  plus  amount  of 
first  6  per  cent,  bonds,  plus  preferred  stock, 
plus  reserves,  which  amount  to  ^31,000,000 — 
from  the  ^41,000,000  assets.  Divide  the  re- 
mainder, which  is  ^10,000,000,  by  the  number 
of  common  shares,  i.e.,  by  50,000,  gives  ^200  a 
share  as  the  book  value  of  the  common  stock. 
Short  method  and  proof  of  the  foregoing: 
Add  the  $5,000,000  account  of  common  stock 
to  the  $5,000,000  surplus  and  divide  the  re- 
mainder by  50,000,  the  number  of  common 
shares — giving  $200  a  share. 

To  find  the  book  value  of  the  preferred  stock, 
subtract  the  Habilities,  including  current  and 
fixed,  plus  reserves,  which  amount  to  $25,000,000 
— from  $41,000,000  assets.  Divide  the  re- 
mainder, which  is  $16,000,000,  by  the  number 
of  shares  of  preferred  outstanding  or  60,000, 
give  $266.67  as  the  book  value  of  the  preferred 
stock. 

Short  method  and  proof  of  the  foregoing: 
Add  the  total  amount  of  the  common  par 
value,  i.e.,  $5,000,000,  the  amount  of  the  pre- 
ferred, $6,000,000,  to  the  $5,000,000  surplus. 
Divide  the  amount  $16,000,000  by  60,000,  the 
number  of  preferred  shares,  and  we  have 
$266.67. 


[69] 


XI 

Comparison  of  Balance  Sheets 
Different  Years 

Gerstenherg — Principles,  741-742;  Cole,  no. 
127-132. 

Collver,  75;     Tovey — Balance  Sheets,  47-58. 

Wall,  Bankers'  Credit  Manual,  1 17-134. 

Wood,  28.  39.  342.  (Shows  Balance  Sheets 
and  Profit  and  Loss  figures  combined.) 

See  also  XVI.     Pages  97-98. 

Many  companies  present  Balance  Sheets 
only — no  Income  Accounts.  Investors  have 
attempted  to  figure  the  actual  earnings  by 
comparison  of  the  latest  with  prior  Balance 
Sheets,  taking  into  consideration  the  dividends 
paid  during  the  year,  i.e.,  increase  in  surplus 
plus  dividends  equals  earnings.  Without  de- 
tailed earning  figures  to  check  up,  the  asset  ac- 
counts can  so  easily  be  juggled  through  excess 
valuation — in  order  to  make  a  good  showing  in 
the  surplus  accounts,  that  the  comparison  may 
be  of  little  value. 

Comparison  of  Balance  Sheets  should  show 
the  change  in  the  amounts  of  current  assets  and 

I  70] 


liabilities,  and  any  change  in  the  relation  of  the 
two. 

A  large  increase  in  inventories,  accompanied 
by  a  corresponding  increase  of  notes  payable 
and  a  shrinking  in  cash  resources,  would  indi- 
cate a  situation  requiring  explanation  in  order 
not  to  appear  dangerous  with  the  prospect  of 
possible  lower  prices  in  commodities  in  view. 
In  fact,  a  large  increase  in  inventories,  no  matter 
how  balanced,  on  the  financial  statement,  is 
often  a  clear  indication  of  dangerous  over- 
expansion. 

It  should  be  remembered  that  an  abnormally 
large  inventory,  however,  even  during  periods 
of  inflation,  may  not  be  indicative  of  dangerous 
condition.  Many  companies  do  not  carry  large 
inventories  awaiting  orders,  but  purchase  raw 
materials  only  after  bona-fide  orders  are  re- 
ceived with  terms  cash  upon  delivery. 

Other  changes,  for  example  the  growth  of 
investments,  will  account  for  the  increase  in  the 
surplus  shown,  while  decrease  in  intangible 
accounts,  such  as  good  will,  indicate  a  general 
strengthening  of  the  corporation's  position  not 
entirely  indicated  by  an  increase  in  surplus. 

Comparison  of  Balance  Sheets  before  and  some 
time  after  bond  or  note  financing  should  indi- 
cate how  the  funds  have  been  used.  Sometimes 
important  in  checking  up  the  "purpose"  of  the 
capitalization.  It  will  easily  be  understood 
that  refunding  finance,  i.e.,  issuance  of  new 
bonds  or  notes  to  take  the  place  of  maturing  is- 

[71] 


sues,  usually  gives  rise  to  fewer  questions  as  to 
whether  the  corporation  can  support  the  issues 
than  in  the  case  of  issuance  of  entirely  new 
securities  with  which  to  engage  in  a  program 
of  wide  expansion,  with  the  speculative  chances 
involved.  Such  speculation  is  minimized  when 
the  new  securities  are  issued  with  which  to  pay 
for  a  purchased,  long-established  competing  or 
allied  business. 

See  Collver,  136. 

For  comparison  of  Balance  Sheets  for  differ- 
ent  years    and   with    different   companies    see 

Cole,  132-138. 


[72] 


XII 

Income  Accounts 

I.     Consistent  Form  Necessary. 

Earnings  are  the  final  measure  of  progress 
and  value.  Great  assets  are  normally  of 
little  avail  unless  capable  of  profitable  use. 
See  X,  Pages  67-68. 

The  Income  Account  shows  the  changes 
which  have  occurred  during  the  period  af- 
fecting the  Balance  Sheet — gives  account  of 
the  conduct  of  the  business  with  losses  and 
gains,  together  with  accounting  of  the  dis- 
posal of  net  results. 

Because  of  lack  of  standardization  in  the 
make-up  of  Income  Accounts  and  because  of 
the  possibilities  of  misrepresentation  in  the 
make-up  of  income  figures,  particularly  in 
those  of  the  "short  and  snappy"  variety, 
skepticism  must  accompany  the  examina- 
tion. 

Accountants  differ  as  to  the  form  of  the 
simplest  Income  Account — even  as  to  the 
name  of  the  account  itself  and  as  to  the  names 
of  items.     -     .     .     Nevertheless,  the  Income 

[73] 


Account  is  usually  easier  to  understand  than 
the  Balance  Sheet,  and  if  the  methods  of  the 
company  in  making  up  statements  are  fair, 
the  Income  Account  may  be  analyzed. 

The  best  assurance  that  the  method  of  ac- 
counting is  legitimate  and  that  the  basis  of 
making  up  the  figures  has  not  changed  from 
one  year  to  another  without  due  warning 
is  the  certification  of  a  reliable  firm  of  public 
accountants.  However,  even  a  properly  certi- 
fied Income  Account  is  of  limited  use  in  analy- 
sis if  it  lacks  in  definiteness  and  detail.  For 
example,  one  of  the  largest  industrials  presents 
the  amount  of  "  Net  Profits  "  carried  to  surplus 
after  all  sorts  of  unspecified  deductions  for 
"Federal  Taxes,  Rentals,  Renewals,  Deprecia- 
tion, and  Contingencies."  Apparently  the 
partner-stockholders  are  not  to  be  trusted 
overmuch  with  information. 

I 

As  showing  the  varied  methods  of  ac- 
counting procedure,  items  such  as  insurance, 
rent,  and  taxes  may  one  year  be  charged  as 
general  expenses,  and  next  year  among  fixed 
charges.  Since  it  is  necessary  to  examine 
and  compare  the  Income  Accounts  of  a 
corporation  for  several  years  in  order  in- 
telligently to  judge  its  earning  power,  it 
follows  that  when  accounts  are  given  in  de- 
tail, yet  have  inconsistencies  in  the  method 
of  handling  the  main  items,  that  the  Income 
Accounts  are  not  comparable  till  adjusted. 

See  Collver,  165-168. 
[74] 


2.  Holding  Company  Figures. 

Collvery  168-169;  Gerstenherg — Principles, 
752-753;  Lyon^  II,  196-208. 

In  the  case  of  a  holding  company,  analysis 
is  apt  to  be  futile  unless  the  results  of  subsi- 
diaries and  holding  company  be  combined 
into  a  consolidated  Income  Account.  Other- 
wise, supposing  that  only  dividends  from 
subsidiaries  are  reported  in  the  holding  com- 
pany's report,  large  losses  of  certain  subsi- 
diaries might  be  concealed.  Conversely, 
large  profits  may  be  hidden  through  the 
accretion  by  certain  subsidiaries  of  undivided 
profits. 

A  fair  basis  of  analysis  is  present  only 
provided  that  detailed  consolidated  Income 
Account  and  detailed  Income  Accounts  of 
each  subsidiary  are  available. 

3.  "Standard^'  Corporation  Form. 

Below  is  given  a  condensed  comparative 
Income  Account  (but  more  detailed  than  usu- 
ally found  in  published  reports).  This  is  as 
published  by  the  Federal  Reserve  Board 
from  forms  prepared  for  the  Federal  Trade 
Commission  by  the  American  Institute  of 
Accountants.  See  Page  76.  This  form 
has  been  adopted  by  large  financial  inter- 
ests as  satisfactory  for  most  industrials,  but 
can  be  used  in  some  lines  only  by  adapta- 
tion. 

[75] 


FORM  FOR  PROFIT  AND  LOSS  ACCOUNT 

Comparative  statement  of  profit  and  loss  for  three  years  ending. 


.19 


Year  ending — 

19— 

19— 

19— 

$ 

$ 

$ 

Less  outward  freight,  allowances,  and  re- 
^^Ufl^S                         , ,. 

Net  sales 



Piirrhases    net.     .     

I-wiq  invf»ntorv  end  of  vear 

Cost  of  sales 

Gross  profit  on  sales 

Selling  expenses  (itemized  to  correspond  with 

Total  selling  expense 

General    expenses    (itemized    to    correspond 

Total  general  expense 

Administrative  expenses  (itemized  to  corres- 
nond  with  ledeer  accounts  kept) 

Total  administrative  expense 

Total  expenses 

Net  profit  on  sales 

Other  income: 

Interest  on  notes  receivable,  etc 

Gross  income 



Deductions  from  income: 

Interest  on  notes  payable 

Total  deductions 



Deduct  special  charges  to  profit  and  loss .  .  . . 

Surplus  beginning  of  period 

Dividends  paid 

SufdIus  endine  of  period 

For  more  detailed  Income  Accounts  see  Wild- 
man,  307-310. 

[76] 


XIII 

Analysis  of  Income  Accounts 

I.     Gross  Sales. 

Collver,  1 71-173;  Lough,  418-421. 

Gross  Earnings  is  given  instead  in  some 
cases,  e.g.,  corporation  dependent  upon  li- 
censing of  patents.  Item,  whether  gross 
sales  or  earnings,  should  designate  total  re- 
ceipts from  regular  corporation  operation. 
Should  include  no  earnings  not  actually  re- 
alized— no  "estimated  profits" — no  proceeds 
from  fixed  assets  sold. 

Comparison  of  Gross  Sales  for  different 
years  should  show  whether  business  improv- 
ing, whether  business  consistent  or  subject 
to  violent  fluctuations.  Should  be  remembered 
that  in  years  of  rising  prices  expansion  in 
Gross  Sales  may  be  more  representative  of 
inflation  in  prices  than  in  quantity  of  sold 
output. 

In  connection  with  other  figures  Gross 
Sales  brings  out  the  profits  per  dollar  of  Gross 
Sales,  which  is  highly  important,  especially 
in  comparison  from  year  to  year. 

I  77  1 


2.     Gross  and  Net  Profit. 

Collver,  173-178;  Lough,  421-422. 

Net  Sales,  i.e.,  the  gross  less  "outward 
freight,  allowances  and  returns"  is  not  often 
given,  though  when  available  it  is  a  valuable 
figure.  In  the  case  of  a  holding  company  re- 
port, the  net  sales  should  exclude  intra- 
company  transactions  which  are  often  highly 
important. 

Cost  of  Sales:  seldom  available  unfortu- 
nately from  reports.  When  given  or  ob- 
tainable by  deduction  from  the  figures, 
subtraction  of  Cost  of  Sales  from  Gross  Sales 
gives  Gross  Profits  on  Sales.  In  a  manufac- 
turing corporation  the  factory  cost  of  produc- 
tion takes  the  place  of  "Purchases,  Net," 
in  the  Income  Account.     See  XII.     Page  76. 

Ratio  of  Gross  Profits  to  Net  Sales  should 
be  calculated  and  compared,  one  year  with 
another,  but  with  allowances  for  general  con- 
ditions and  results  of  similar  corporations. 
Except  in  times  of  inflation  competition 
will  tend  to  decrease  the  Ratio  of  Gross 
Profits  to  Net  Sales  in  spite  of  the  best  man- 
agement. 

Owing  to  lack  of  standardization  in  the 
making  up  of  accounts,  and  the  frequent 
inclusion  in  factory  costs  of  important  im- 
provements and  extensions,  a  decrease  in 
Ratio  of  Gross  Profits  to  Net  Sales  may  indi- 
cate increase  conservatism  of  management. 

If  the  decrease  is  consistent  and  caused  by 

[78] 


increased  cost  of  labor,  power,  etc.,  the  de- 
crease is  to  be  considered  unfavorably.  Since 
particulars  are  usually  unavailable,  unless  it 
can  be  proved  that  maintenance  and  depre- 
ciation charges  have  been  neglected,  an  in- 
creasing Ratio  of  Gross  Profits  to  Net  Sales  is 
normally  to  be  considered  as  evidencing  in- 
creasingly profitable  operations,  and  a  de- 
creasing ratio  as  at  least  dubious. 

Selling,  General,  and  Administrative  Ex- 
penses are  seldom  found  in  published  re- 
ports. Items  which  make  up  these  separate 
accounts.  Many  corporations  reporting  large 
expenses  are  really  cutting  down  taxable 
profits  through  abnormally  large  advertising 
campaigns. 

Gross  Profits  on  Sales,  less  Selling,  General 
and  Administrative  Expense,  gives  Net  Prof- 
its, sometimes  called  Net  Profits  on  Sales. 
Ratio  of  Net  Profits  to  Net  Sales  for  different 
years  should  be  figured  and  compared,  but 
with  caution.  Of  course,  a  company  having 
a  rapid  turnover  such  as  a  packing  company 
cannot  be  expected  to  have  as  large  a  Ratio 
of  Net  Profits  to  Net  Sales  as  in  the  case  of  a 
bridge  corporation  which  may  do  very  well 
in  turning  over  its  capital  once  a  year. 

When  Gross  Sales  are  given  Net  Profits 
are  usually  also  published.  The  ratio  of  the 
latter  to  the  former  is  the  most  valuable  that 
can  be  worked  out  from  the  Income  Account. 
It  is  reached  after  all  the  primary  cost  and 
expense   items   are   supposed   to   have   been 

[79] 


charged  off,  no  matter  how.  Too  often  com- 
parison is  difficult  owing  tjo  the  tendency  to 
skimp  renewals,  depreciation,  etc.,  in  poor 
years,  relying  on  especially  good  years  in 
which  to  make  up  deficiencies.  Of  course,  re- 
newals, depreciation,  etc.,  should  be  con- 
sidered as  part  of  cost  in  all  years.  Without 
detailed  accounts  or  knowledge  as  to  the 
corporation  management's  procedure,  it  may 
be  difficult  to  tell  which  policy  has  been 
adopted. 

3.     Other  Income. 

Coiiver,  179-180;  Wild  man,  225-230. 

Special  profits  or  losses  should  be  shown 
separately,  and  placed  in  Other  Income  Ac- 
count in  case  of  profit,  or  deducted  from  Net 
Earnings  in  case  of  loss.  For  example,  from 
1914-1918  many  industrials  organized  spe- 
cial departments  to  carry  on  business  strange 
to  the  organizations:  war  materials  of  vari- 
ous sorts.  Unless  results  from  such  efforts 
are  separated,  comparison  with  results  in 
other  years  would  be  difficult. 

Usual  source  of  Other  Income  Is  Interest 
and  Dividends  from  securities  owned.  If 
amount  is  large  it  is  highly  important  to 
give  special  attention  to  the  securities  held. 
In  some  instances  corporations  have  issued 
their  own  securities  in  order  to  pay  for  those 
held  in  the  treasury.  Discontinuance  of  the 
income  might  be  disastrous  to  the  holder. 

[80] 


Quite  usual  for  corporations  to  have  interest 
in  others  which  have  complementary  work. 

Example.  Example  of  large  corporation 
which  has  large  general  investments  pur- 
chased from  profits. 

Interest  on  bank  balances  and  rentals  are 
also  Other  Income. 

Proceeds  of  capital  assets,  often  included 
in  Other  Income,  Should  not  be.  Should 
include  only  the  profit  on  any  such  trans- 
action— any  loss  to  be  deducted  from  Net 
Earnings — leaving  Balance  Sheet  and  Income 
Account  in  natural  accord.  Still  better  to 
include  such  unusual  source  of  income  with 
Profit  and  Loss,  keeping  even  the  Other 
Income  Accounts  for  different  years  as  nearly 
comparable  as  possible. 

Special  profits  should  not  include  arbitrary 
increases    in    assets   or    "estimated    profits' 
from  incomplete  operations. 

Total  or  Gross  Income. 

Collver,  i8i;  Wildman,  231-234. 

Account  obtained  by  adding  Other  Income 
to  Net  Profits.  Accountants  differ  greatly 
as  to  the  items  which  should  be  deducted 
from  Total  or  Gross  Income  and  which 
should  be  taken  into  consideration  before  this 
account  is  reached.  As  giving  the  view  of 
one  authority: 

"The  Other  Income  added  to  the  Net 
Profits    gives    the   Total   or   Gross    Income. 

[81] 


From  the  Total  Income  are  deducted  Federal 
taxes,  Interest  on  bank  loans  and  bonds, 
Amortization  of  bond  discount,  and  Cash  Dis- 
counts on  sales.  These  expenditures  are 
subtracted  from  Total  Income  because  they 
are  considered  expenses  of  capital,  the  ex- 
pense of  obtaining,  using,  and  protecting  capi- 
tal, set  up  separately  in  order  to  show  what 
the  Total  Income  would  be  if  there  were  no 
expenses  in  connection  with  capital.  Inter- 
est actually  belongs  among  the  expenses  of 
capital,  of  course,  but  is  like  Federal  taxes 
usually  separated  in  published  reports  for 
convenience  in  analysis." 

Interest. 
Collver,  183. 

The  Income  Account  should  show  sepa- 
rately interest  paid  on  funded  obligations  and 
interest  on  bank  loans,  notes,  and  accounts 
payable.  Indication  that  the  company  has 
important  accounts  payable  past  due  if 
the  Balance  Sheet  shows  a  small  amount  of 
loans — from  banks — ^with  an  Income  Account 
showing  a  relatively  large  amount  paid  for 
interest  on  short -time  loans. 

If  interest  rates  have  been  fairly  normal 
during  the  period  and  the  credit  of  the  com- 
pany good,  the  amount  of  unfunded  liabili- 
ties requiring  interest  can  many  times  be 
calculated  roughly,  even  though  the  amounts 
paid  are  not  stated  separately. 

[82] 


"Suppose  the  total  interest  paid  is  ^100,000 
and  the  Balance  Sheet  shows  ^500,000  5  per 
cent,  bonds  and  $5cxd,cxxd  6  per  cent,  notes, 
the  funded  debt  would  require  ^25,000  plus 
$30,000  or  $55,000  showing  $45,000  applied  to 
unfunded  debts.  If  fair  interest  rates  were 
about  5  per  cent.,  the  Balance  Sheet  would 
probably  include  twenty  times  the  interest 
charges,  or  $900,000,  of  unfunded  interest- 
bearing  loans." 

Profit  and  Loss  Surplus. 
Collver,  185,  186;  iVildman,  276-279. 

As  shown  by  the  Income  Account  XII-3, 
on  Page  76,  the  remainder  after  interest 
charges  is  Net  Income.  Then  should  come 
any  special  additions  or  deductions.  Addi- 
tions will  be  such  as  profits  on  plant  or  other 
capital  assets,  such  as  securities  sold.  Deduc- 
tions will  be  amounts  written  off  in  reducing 
such  accounts  as  Good  will  and  Patents,  De- 
preciation, Provision  for 'Doubtful  Accounts, 
and  Discount  on  Bonds  Written  Off. 

However,  most  corporations  bring  in  spe- 
cial additions  and  deductions  before  interest 
is  deducted. 

Since  dividends  are,  for  any  period,  legally 
payable  from  earnings  accrued  since  the  or- 
ganization of  a  company,  it  is  technically  cor- 
rect to  add  the  Surplus  at  Beginning  of  Pe- 
riod directly  to  the  ''Profit  and  Loss  for 
Period  "  as  shown  on  Page  76.     .     .     ,  then  to 

[83I 


deduct  dividends,   preferred   dividends   first, 
and  leaving  Surplus  Ending  of  Period. 

Most  corporations  show  the  Profit  and 
Loss  for  Period — usually  called  Net  Profits 
— deduct  dividends,  and  add  the  remainder 
to  the  Surplus  Beginning  of  Period.  As  to 
policy  in  declaring  dividends  see  V.  2D. 
Page  30. 

Margin  of  Safety. 
Collver,  187-188. 

"The  Margin  of  Safety  of  Bonds  is  the 
Proportion  of  Net  Income  left  after  paying  all 
fixed  charges.  A  company  which  earns 
^1,000,000  and  has  $200,000  fixed  charges, 
leaving  $800,000,  or  80  per  cent.  Margin  of 
Safety  above  fixed  charges  should  be  in  better 
condition  than  if  it  had  the  same  earnings  and 
$800,000  fixed  charges,  or  a  Margin  of  Safety 
of  20  per  cent. 

"The  Margin  of  Safety  over  preferred  stock 
may  easily  be  reckoned  by  including  after 
Profit  and  Loss  entries,  if  any,  the  required 
dividends  on  the  stock  with  the  fixed  charges 
before  figuring  the  percentage.  The  Margin 
of  Safety  over  the  common  stock  may  be  com- 
puted by  including  its  dividend  return  with 
the  fixed  charges  and  the  preferred  dividend 
returns.  Suppose  with  $1,000,000  earnings, 
fixed  charges  are  $200,000,  preferred  dividends 
$200,000,  and  common  dividends  $200,000. 
The  fixed  charges  and  all  dividends  are 
$600,000,  and  the  remainder,  $400,000,  is  40 

[84] 


per  cent.,  which  is  the  Margin  of  Safety  over 
the  common  stock  disbursements. 

"The  strength  of  a  corporation  may  fairly  be 
tested  by  the  Margin  of  Safety,  checking  up 
other  conclusions.  If  the  Margin  of  Safety 
over  the  different  classes  of  securities  is 
increasing,  other  things  being  equal,  the  cor- 
poration's bonds  and  stocks  may  be  consid- 
ered as  growing  safer  and  stronger." 

8.     Average  Profits. 
Collver,  1 88. 

The  "Average  Profits"  are  many  times 
given  in  security  circulars  in  place  of  figures 
for  separate  years,  simply  because,  unfor- 
tunately, investors  wish  generalities  and  do 
not  welcome  "statistics."  Deception  may 
lie  in  "average  profits"  which  may  show  a 
good  figure,  entirely  adequate  for  a  pro- 
posed new  bond  or  preferred  stock  issue,  in  the 
face  of  dangerously  decreasing  or  fluctuating 
earnings,  but  the  investor  has  himself  to 
thank  that  complete  figures  are  often  not 
given.  Many  times  a  good  reason  exists  for 
a  sharp  decline,  such  as  a  flood  or  other  local 
disaster,  or  a  sympathetic  strike.  The  con- 
servative, discriminating  investor  will  find 
the  record  of  several  consecutive  years,  even 
when  containing  a  reasonably  explained  lean 
period,  more  attractive  than  the  uncertain- 
ties of  "Average  Profits"  which  may  be  help- 
ful, however,  if  conditions  have  been  fairly 
normal  throughout  the  years  averaged. 

[85] 


XIV 
Form  and  Amount  of  Capitalization 

The  outstanding  lesson  of  twenty  years' 
experience  in  industrial  finance  in  this  coun- 
try is  that  the  style  or  jorm  of  capitalization 
is  of  paramount  importance.  See  IX.  i. 
Pages  50-51. 

1.  Relation  to  Physical  Value. 

See  Outline  of  Corporation  Finance  and 
Investment,  Pages  27-31.  Adjusting  Capi- 
talization to  Assets.     Lough,  1 89-191. 

2.  Relation  to  Earnings  and  Gross  Sales. 

Lough,  179-189,  221-223,  513-514.  Lyon, 
I,  83-107. 

Corporations  are  usually  capitalized  upon 
earning  power,  present  or  prospective,  though 
bonds  certainly,  and  nearly  always,  preferred 
stock,  represent  tangible  assets. 

From  Lough,  513-514:  ''Industrials  fre- 
quently show  a  total  capitalization  equal 
to  their  gross  earnings.     This  relation  may 

[86] 


easily  exist  wherever  the  percentage  of  profit 
on  sales  is  about  equivalent  to  the  percentage 
of  profit  expected  in  that  industry  .  .  . 
Companies  which  do  a  large  business  on  a 
small  margin,  commission  houses,  retail 
stores,  manufacturers  of  staples,  and  the  like, 
will  customarily  have  a  capitalization  much 
smaller  than  gross  sales." 

For  specific  comparison  of  several  im- 
portant electric  manufacturing  companies 
see  Lough,  515-518. 

It  is  a  fallacy  to  issue  bonds  against  ex- 
pected earnings,  or  in  the  case  of  a  holding 
company,  upon  the  aggregate  earnings  of  the 
constituent  companies  prior  to  their  com- 
bination, as  the  results  of  the  amalgamation 
may  be  disappointing.     See  Dewing,  547. 

Borrowing  limited  by  liability  of  net 
earnings  to  fluctuate.  See  IX.  i.  Pages  50-51. 
See  also  Lyon  I,  54. 

In  case  of  a  holding  company  issuing  se- 
curities, the  investor  should  go  back  of  the 
purported  earnings  available  for  interest  or 
preferred  dividend  charges.  The  amount 
available  for  interest  or  dividend  charges 
may  be  almost  entirely  from  dividends  received 
from  operating  subsidiaries.  In  a  year  of 
declining  business  the  operating  companies 
which,  we  will  assume,  have  large  interest 
requirements,  may  suffer  a  loss  in  net  earn- 
ings available  for  their  fixed  charges.  This 
loss,  while  very  small  in  comparison  to  the 

[87] 


total  business  of  the  operating  companies, 
may  be  just  enough  to  wipe  out  all  earnings 
which  the  holding  company  depends  upon 
in  order  to  take  care  of  the  holding  company's 
interest  or  preferred  dividend  requirements. 
This  point  simply  emphasizes  the  necessity 
of  having  complete  information  available  in 
regard  to  both  holding  company  and  subsi- 
diary affairs.  The  least  that  the  investor 
should  require  would  be  consolidated  Balance 
Sheets  and  Income  Accounts.  The  latter 
would  show  the  amount  available  against  all 
interest  requirements.  See  XII.  2.  Page  75. 
See  LyoUy  II,  196-208. 

Circulars  usually  show  that  earnings  avail- 
able for  interest  amount  to  so  many  times 
the  amount  required.  The  investor  should 
see  that  the  amount  required  includes  all 
the  fixed  liabilities  and  not  simply  the  re- 
quirements on  the  issue  offered.  A  Note  is- 
sue may  show  requirements  earned  ten  times 
— taking  the  amount  available  after  paying 
all  other  bonds.  Applying  the  amount  avail- 
able for  fixed  charges  against  all  fixed  obliga- 
tions, including  the  offered  issue,  may  show 
requirements  earned  but  twice— using  the 
figures  taken  from  the  same  Income  Account. 
Perfectly  proper  to  show  the  earnings  and 
requirements  both  ways. 


[88] 


XV 

Special  Financial  Standards 

Since  industrial  activity  has  been  so  varied, 
and  standards  of  accounting  used  by  industrial 
corporations  almost  as  varied,  no  such  accurate 
standards  of  operation  and  finance  are  possible 
as  in  the  railroad  field.  However,  a  most  help- 
ful beginning  has  been  made. 

Wall — Financial  Statements.    See  also  Wall — 
Bankers'  Credit  Manual,  132-133,  137-164. 
I.  ^' The  Tzvo-Jor-one  Rule,"  i.e.,  that  a  financial 
statement   must     show    at    least    two    dollars 
of   current   assets    (including    inventories)    for 
every  dollar  of  current  liability  in  order  to  show 
a  good  credit  proportion.     "Dressing"  a  finan- 
cial statement  to  make  a  good  showing. 
Supplementary  ratios  as  follows: 

(A)   Comparison  from  year  to  year:  Ratio 
Accounts  and  Notes  Receivable  to   Mer- 
chandise. 
If  percentage  increases  we  should  expect 
to  find   an  increasing  percentage  of  profits 
included  in  current  assets,  and  therefore  an 
increase  in  the  ratio  of  current  assets  to  cur- 
rent liabilities. 

[89I 


(B)  Ratio  Net  Sales  to  Accounts  and  Notes 
Receivable.  Shows  the  Hquidity  of  the  re- 
ceivables and  is  a  most  important  quaUtative 
consideration  in  judging  the  rapidity  of  col- 
lection. 

(C)  Ratio  Sales  to  Merchandise.  Shows  the 
liquidity  of  merchandise. 

(D)  Ratio  of  Net  Worth  to  Fixed  Assets. 
If  a  falling  one  denotes  expansion  in  plant 
perhaps  more  rapid  than  advisable.  See 
note  after  (F). 

(E)  Ratio  of  Sales  to  Net  Worth.  High  ratio 
may  in  certain  lines  denote  under-capitaliza- 
tion  and  a  feverish  condition.  Low  rates  may 
indicate  dry  rot  or  unprofitable  use  of  in- 
vested funds.     See  note  after  (F). 

(F)  Ratio  of  Total  Debt  to  Net  Worth.  Shows 
the  proportion  of  the  total  capital  used  sup- 
plied by  creditors  and  by  the  owners  of  the 
business. 

NOTE:  Net  Worth  is  the  Book  Value 
of  all  stocks,  preferred  and  common,  of  a 
corporation,  and  is  obtained  simply  by 
subtracting  the  liabilities,  including  re- 
serves and  all  fixed  obligations,  of  course, 
from  the  total  assets.    See  X,  Page  G6. 

Necessity  of  understanding  different  pro- 
portions that  normally  exist  in  different  lines 
of  business,  and  between  companies  operat- 
ing in  different  parts  of  the  country. 

/     Wall — Credit   Barometrics.  Includes  thirty 
tables    of   statistics   including   actual   ratios 

[90] 


taken  from  many  establishments  in  industrial 
lines.  See  also  Kniffin,  444-445  in  re  the 
"Two-to-One  Ratio." 

(G)  Ratio  of  Sales  to  Fixed  Assets.  Shows 
the  dollars  of  net  sales  for  every  dollar  in- 
vested in  plant  and  non-liquid  assets.  This 
ratio  may  be  used  in  connection  with  Ratio 
of  Net  Worth  to  Fixed  Assets  (D).  If  worth 
to  fixed  assets  falls  and  sales  to  fixed  assets 
also  be  a  falling  ratio,  shows  plant  is  enlarg- 
ing faster  than  net  worth  and  at  the  same 
time  its  sales  productivity  is  not  keeping  pace 
with  increase  in  size. 

In  considering  ratios  allowance  must  be 
made  for  different  conditions  in  general 
business.  Time  of  year  may  be  important. 
Usually  not  fair  to  compare  a  January  with  a 
July  Statement. 

2.     Other  Financial  Standards. 
Lough,  500-524. 

(A)  Relation  of  Working  Capital  to  Total 
Capital,  i.e.,  total  par  value  of  stocks 
and  bonds. 

"With  almost  no  exceptions,  companies 
which  are  competitive  or  in  the  same  general 
class  of  business  have  approximately  the 
same  relations  of  working  to  total  capital." 
Companies  which  have  to  carry  large  inven- 
tories or  materials,  goods  in  process  and  fin- 
ished goods,  and  those  which  find  it  necessary 
to  sell  on  an  instalment  or  long-term  basis, 

[91I 


require  a  large  actual  and  relative  amount  of 
working  capital.  Figures  from  prominent 
corporations  given. 

(B)  Cash  and  Cash  Resources.  Relation  of 
Cash  and  Cash  Resources  (Resources  imme- 
diately convertible  into  cash,  principally 
securities  held  for  sale)  to  total  capital,  to 
gross  volume  of  business,  and  to  current  li- 
abilities. 

Financial  corporations  have  practically  all 
their  capital  in  cash  and  cash  resources. 
Proportion  to  demand  habilities  is  from  15 
to  25  per  cent.  Purely  industrial  corpora- 
tions have  from  i  to  16  per  cent,  of  total 
capital  in  cash.  Seldom  runs  above  7  or  8 
per  cent.,  which  is  above  average. 

Canadian  and  most  foreign  companies  de- 
pend more  upon  their  banks  than  do  industri- 
als in  this  country,  and  carry  proportionately 
little  cash. 

Most  industrials  in  this  country  have  on 
hand  at  the  end  of  the  fiscal  year  3  to  6  per 
cent,  of  the  amount  of  gross  sales  in  cash. 
If  a  company  pays  bills  promptly  and  does 
not  overborrow,  current  liabilities  should  not 
exceed  20  to  30  per  cent,  of  annual  sales — 
referring  to  company  making  articles  which 
sell  in  steady  volume.  Follows  that  cash 
and  cash  resources  should  be  about  12  to  25 
per  cent,  of  current  liabilities,  which  is  about 
average. 

(C)  Turnover.     Depends    upon    nature    of 

[92] 


company.  Commission  selling  house  carrying 
no  stock  ordinarily  has  a  very  large  turnover 
— to  i,ooo  per  cent,  of  working  assets  or 
higher.  Large  department  store  turns  over 
entire  stock  about  twice  a  year.  Many  grocery 
stores  have  a  turnover  once  a  month.  In  re 
manufacturing  companies,  depends  upon  na- 
ture of  manufacture.  Should  be  remembered 
that  working  assets  vary  considerably  from 
season  to  season,  and  variation  in  this 
amount  makes  a  large  difference  in  figuring 
turnover. 

See  also  Loughy  384-388;  Kniffen,  420-421, 
448-449,  458. 

Gerstenberg — Principles,  748-49. 

(D)  Operating  Ratio.  (A /^rw  not  accepted 
generally  by  accountants  in  regard  to  in- 
dustrial activity,  but  corresponding  roughly 
to  the  railroad  term — C.C.)  Is  "percentage 
of  total  expense  of  running  the  business,  in- 
cluding manufacturing,  selling,  and  adminis- 
tration, to  the  gross  sales.  It  is  clear  that 
the  difference  between  100  per  cent.,  which 
represents  gross  sales  and  the  operating  ratio, 
is  the  percentage  of  gross  profit  to  sales." 

See  also  XIII.  2.  Page  78. 

From  Lough,  51 1-5 13:  "The  lower  this 
percentage  of  gross  profit,  or,  in  other  words, 
the  higher  the  operating  ratio,  the  more  un- 
stable, other  things  being  equal,  is  the  busi- 
ness as  a  money  maker:  for  a  high  operating 
ratio  means  that  even  a  slight  variation  in 

[93] 


expenses  may  be  sufficient  to  transform  a 
profit  into  a  loss.  On  the  other  hand,  a 
phenominally  low  operating  ratio  indicates  a 
business  which  is  earning  excessive  profits 
and  is  therefore  peculiarly  subject  to  com- 
petitive attack." 

"Companies  which  manufacture  special- 
ties that  enjoy  a  ready  market  and  are  pro- 
tected by  patents  or  otherwise,  from  effec- 
tive competition,  may  properly  have  a  light 
operating  ratio  and  an  unusually  large  per- 
centage of  profits  on  sales." 

See  table,  Lough,  512. 


[94I 


XVI 

New  Promotions 

General  Considerations. 

Collver,  189-200;  Jordan,  362-367;  Cooper, 
48-108,  414-429,  503-509;  Lough,  236- 
237,  246-249. 

In  every  general  business  boom  thousands 
of  fraudulent  new  securities  are  issued  by  a 
multitude  of  "fly-by-night"  pronioters.  Such 
offerings  appeal  to  the  unreasoning  greed  of 
the  unwary.  However,  the  loss  to  the 
impecunious  multitude  who  believes  that 
purchasing  the  "unusual  opportunity"  is 
actually  investing,  is  so  great  as  to  be  a  serious 
economic  loss  to  the  country,  as  well  as  to 
the  individuals  directly  affected,  not  to  con- 
sider the  loss  of  business  to  legitimate  invest- 
ment dealers. 

It  is  dangerous  to  capitalize  a  new  propo- 
sition on  a  basis  of  business  and  earnings 
possible,  or  even  actual,  in  boom  times. 
Moreover,  assets,  even  at  bona-fide  valua- 
tions, may  appear  excessive  later  on. 

Some  must  pioneer,  but  unless  one  can  well 

[95] 


afford  the  chance,  and  is  well  informed  in 
regard  to  every  phase  of  a  new  proposition, 
particularly  in  regard  to  its  management 
and  the  offering  house,  a  new  promotion  may 
usually  be  neglected  without  ultimate  regret. 

A  large  part  of  new  propositions  involve  re- 
capitalization of  old-established  businesses. 
New  securities  so  based,  and  offered  by  ex- 
perienced and  reputable  houses,  are  not  to 
be  considered  "New  Promotions,"  although 
if  the  new  financing  provides  for  unwar- 
ranted expansion,  difficulties  may  arise. 

Citations  as  to  success  of  other  ventures 
nearly  always  simply  "bait" — difficulties  in 
the  early  experiences  of  enterprises  widely 
heralded  by  the  "get-rich-quick"  fraternity. 

Most  certain  indication  of  "promotion" 
stock  is  statement  that  reflects  against  Wall 
Street  banks  and  methods.  Wall  Street  is 
not  perfect,  but  few  if  any  security  advertise- 
ments or  circulars  abusing  "Wall  Street"  will 
stand  analysis. 

Unless  a  new  promotion  is  well  sponsored, 
doubt  must  be  dispelled  in  regard  to  the  most 
elementary  statement  on  the  prospectus. 
Many  cases  have  arisen  of  corporation  issues 
having  been  floated  on  the  representation 
of  ownership  of  plants  which  were  simply  op- 
tioned or  not  controlled  at  all. 

In  many  instances,  within  a  year  or  two 
after  the  flotation  of  a  speculative  "promo- 
tion" stock,  not  only  will  no  market  be  avail- 

[96] 


able  for  the  "securities"  but  no  information 
will  be  available  as  to  conditions  affecting 
them.  For  example,  a  stock  was  widely  mar- 
keted not  long  ago  as  high  as  more  than  $50 
a  share,  on  indications  of  huge  earnings.  A 
request  for  information  recently  was  met 
by  the  following:  "In  view  of  our  desire  to 
forestall  any  activity  in  the  market  at  this 
time  we  are  issuing  no  detailed  statements  re- 
garding the  present  financial  status  or  future 
earnings  of  the  corporation." 

Price  below  par  is  a  common  lure — little 
difference  as  to  the  price  common  stock  is  sold 
originally  as  a  rule — if  enough  is  sold  to  meet 
requirements.  May  legitimately  be  sold 
"Part  paid"  and  calls  made  as  necessary. 

Stock  sold  to  the  public  is  often  "bonus 
stock"  given  to  the  promoter.  In  such  case 
the  sale  does  not  benefit  the  company's  treas- 
ury. Good  management  the  first  considera- 
tion. Possibihty  that  earnings  be  absorbed 
by  "insiders." 

Seldom  profitable  to  buy  new  securities 
simply  because  issued  by  new  local  enterprise. 

.     Special  Information   Tests  in  re  New  Pro- 
motions. 

Listing  .Statement  requirements.  Call  at- 
tention to  much  important  definite  informa- 
tion— but  no  responsibility  is  taken  for  such 
statements. 

Prospective    purchaser    should     ascertain 

[97] 


whether  Balance  Sheet  submitted  is  before  or 
after  receipt  of  funds  from  sale  of  securities 
offered.  Should  be  certain  that  full  capital 
requirements  have  been  underwritten  by  re- 
sponsible houses. 

Unreasonable  percentage  of  security  re- 
ceipts taken  by  "promotion"  security  houses, 
which  may  vanish  after  a  security  "goes 
wrong." 

"Cellar-garret  level."     Collver,  200-204. 

Inadequacy  of  state  "Blue-Sky"  Laws. 
Ease  of  evasion.  Danger  to  investor  and  legi- 
timate investment  dealer.  Suggestions  for  a 
reasonable  and  protecting  Federal  Law.  An- 
nals.    Annals — Reed^  177-187. 

Text  of  Blue-Sky  Laws   of  the   different 

States.     Elliott  and  Rollins-Spring. 

Summary  of  Blue-Sky  Laws.     Reed^  Dough- 
erty, i^  Hoyt. 

Digest  of  provisions  of  the  British  Com- 
panies Act.  Collver,  201-202;  Tovey — Pros- 
pectuses, 59-66  gives  important  paragraphs 
in  full. 

Federal  Trade  Commission  Query.  Does 
not  provide  for  information  in  the  future,  but 
publicity  of  information  required  by  such  a 
Query  would  revolutionize  questionable  se- 
curity practices  which  have  not  changed  in 
hundreds  of  years.  Text  of  Query  given  in 
Collver,  205-208. 


[98] 


XVII 

Receiverships  and  Reorganizations 

Unfortunately  space  is  lacking  for  detail  in 
regard  to  these  subjects.  Valuable  material  is 
easily  available  as  to  Causes  of  Receivership, 
Purpose  of  Reorganization,  Method  of  Effecting 
Reorganizations,  Effect  on  Securities,  etc. 

The  entire  text  of  Dewing  is  of  great  value. 
This  book  includes  the  history  of  some  twenty 
large  companies  which  passed  through  receiver- 
ship and  reorganization,  with  special  chapters  on 
"The  Promotion  of  ConsoHdations  which  have 
undergone  Reorganization,"  "Causes  leading 
to  Reorganization,"  and  "Reorganization  Ex- 
pedients." 

Other  sources  of  importance  are  Lough,  573- 
616;  Gerstenherg — Principles,  170-182. 

Haney,  327-341;  Jordan,  351-361;  Lyon, 
II,  221-307. 


[99I 


COMPLETE  BIBLIOGRAPHY 

The  Annals  of  the  American  Academy  of  Political  and 
Social  Science.  March,  1920,  Number.  Edited  by  S.  S. 
Huebner.  Articles  by  John  Moody,  Robert  R.  Reed, 
and  Hastings  Lyon  cited.     Pubhshed  in  Philadelphia. 

Approved  Methods  for  the  Preparation  of  Balance  Sheet 
Statements.  (Reprint  of  "Uniform  Accounting"  in  Fed' 
eral  Reserve  Bulletin  for  April,  1917.)  Submitted  by  the 
Federal  Reserve  Board.  Pamphlet  form.  Washington, 
1918.  Government  Printing  Office.  Contains  valuable 
material  on  both  Income  Account  and  Balance  Sheet. 

Chamberlain — The  Prijiciples  of  Bond  Investment.  By 
Lawrence  Chamberlain.  191 1.  New  York.  Henry 
Holt  and  Co. 

Cole — Accounts.  Their  Construction  and  Interpretation. 
By  William  Morse  Cole.  Boston.  1915.  Hough- 
ton Mifflin  Co. 

CoLLVER — How  to  Analyze  Industrial  Securities.  By 
Clinton  CoUver.  New  York.  1921.  Moody's  In- 
vestors' Service. 

Cooper — Financing  an  Enterprise.  New  York.  191 S- 
The  Ronald  Press.     Temporarily  out  of  print. 

Corporation  Finance  and  Investments.  Outline  of  Courses 
of  Study.  Prepared  by  Hastings  Lyon  for  the 
Investment  Bankers'  Association  of  America.  Edu- 
cation Committee.  Published  by  Doubleday, 
Page  &  Co.  for  the  Association.     New  York.     1917. 

Dewing — Corporation  Promotions  and  Reorganizations. 
By  Arthur  S.  Dewing.  Boston.  1914.  Houghton 
Mifflin  Co. 

[loi] 


Elliott — Annotated  Blue-Sky  Law  of  the  United  States. 
By  John  M.  Elliott.  Cincinnati.  1919.  The 
W.  H.  Anderson  Co. 

Gerstenberg — Materials  of  Corporation  Finance.  By 
Charles  W.  Gerstenberg.     1918.     Prentice-Hall. 

Gerstenberg — Principles  of  Business.  By  Charles  W. 
Gerstenberg.     New     York.     1918.     Prentice-Hall. 

Haney — Business  Organization  and  Combination.  By 
Lewis  H.  Haney.  New  York.  1915.  The  Mac- 
millan  Co. 

Hatfield — Modern  Accounting.  By  Henry  Rand  Hat- 
field.    New  York.     1920.     D.  Appleton  &  Co. 

Jordan — Investments.  By  David  F.  Jordan.  New  York. 
1920.     Prentice-Hall. 

Kniffin — The  Practical  Work  of  a  Bank.  By  William  H. 
Kniffin,  Jr.  New  York.  1919.  The  Bankers' 
Publishing  Co. 

Lilly — Individual  and  Corporation  Mortgages.  A  state- 
ment for  Laymen  of  the  Legal  Principles.  By 
William  Lilly.  Published  by  Doubleday,  Page  & 
Co.,  for  the  Investment  Bankers'  Association  of 
America.     New  York.     19 18. 

Lough — Business  Finance.  By  William  H.  Lough,  New 
York.     1919.     Ronald  Press. 

Lownhaupt — Investment  Bonds.  By  Frederick  Lown- 
haupt.     New  York.     1908.     G.  P.  Putnam's  Sons. 

Lyon — Corporation  Finance.  By  Hastings  Lyon.  Com- 
plete Edition.  1918.  Vols.  I  and  11  bound  together. 
Boston.     Houghton  Mifflin  Co. 

Mead — Corporation  Finance.  By  Edward  Shervvard 
Mead.     New  York.      1918.     D.  Appleton  &  Co. 

Reed,  Dougherty  &  Hoyt — Summary  of  Blue-Sky  Laws. 
A  digest  of  the  salient  features  of  the  Blue-Sky 
Laws.  By  Messrs.  Reed,  Dougherty  and  Hoyt  for 
the  Investment  Bankers'  Association  of  America. 
New  York.     1920.     (In  preparation.) 

Ripley — Trusts,  Pools,  and  Corporations.  By  William  Z. 
Ripley.     Ginn  &  Co.     1905. 

Rollins-Spring — Blue-Sky  Laws.  By  Montgomery 
Rollins.    Text  of  the  laws  of  the  different  States 

[  102] 


—with  discussion  of  court  decisions  by  Samuel 
Spring.  Loose  Leaf.  Boston.  19 19.  The  Fi- 
nancial Publishing  Co. 

Saliers — Principles  of  Depreciation,  Includes  bibliog- 
raphy. By  Earl  A.  Saliers.  New  York.  1918. 
The  Ronald  Press  Co. 

Saliers — Financial  Statements.  By  Earl  A.  Saliers. 
New  York.     1917.     The  Magazine  of  Wall  Street. 

The  Stock  Exchange  Business — Outline  of  a  course  of 
Study.  Prepared  by  S.  S.  Huebner.  New  York. 
1918.  Published  by  Doubleday,  Page  &  Co.  for  the 
Investment  Bankers'  Association  of  America  and 
the  Association  of  Stock  Exchange  Firms  at  the 
instance  of  the  Education  Committee  of  the  In- 
vestment Bankers'  Association.     New  York.     1918. 

TovEV — Balance  Sheets.  How  to  Read  and  Understand 
Them.  By  Philip  Tovey.  London.  Sir  Isaac  Pit- 
man &  Sons.     New  York. 

TovEY — Prospectuses.  How  to  Read  and  understand 
Them.  By  Philip  Tovey.  London.  Sir  Isaac 
Pitman  &  Sons,  New  York. 

Wall — The  Bankers'  Credit  Manual.  By  Alexander  Wall. 
Indianapolis.     1919.     Bobbs-Merrill  Co. 

Wall — Credit  Barometrics.  By  Alexander  Wall.  Pre- 
pared for  the  Federal  Reserve  Board  and  published 
in  the  March,  1919,  number  of  the  Federal  Reserve 
Board  Bulletin  (now  out  of  print).  Published  in 
pamphlet  form  by  the  National  Bank  of  Commerce, 
Detroit. 

Wall — Financial  Statements.  By  Alexander  Wall._  Is- 
sued by  the  Robert  Morris  Associates.  (National 
Organization  of  Bank  Credit  Men.)  Pamphlet 
available  from  Secretary's  office,  Lansdowne,  Pa. 

WiLDMAN — Principles  of  Accounting.  By  John  Raymond 
Wildman.     New  York.     1920. 

Wood — Unified  Accounting  Methods  for  Industrials.  By 
Clinton  E.  Wood.  New  York.  1919.  The  Ron- 
ald Press  Co. 


[  103] 


PRINCIPAL  SOURCES  OF  INFORMATION 

[.      PRINCIPAL     SOURCES    OF    INFORMATION    IN    REGARD    TO 
INDIVIDUAL    INDUSTRIAL    CORPORATIONS 

1.  Annual  manual  and  book  of  "Analyses":  former  by 

Poor's  Publishing  Company,  the  latter  by  Moody's 
Investors  Service.  Manual  of  Statistics.  Annual 
Manual  of  Statistics  Company. 

Fitch  Publishing  Company  Bond  Book-annual  with 
weekly  revisions. 

Standard  Statistics  Company  stock  and  bond  cards 
with  supplemental  news  service.  Poor's  news  ser- 
vice of  corporations. 

2.  Corporation  Annual  Reports.     Of  particular  value. 

Often  contain  valuable  information  which  com- 
mercial publishers  of  information  cannot  be  ex- 
pected to  furnish.  Digest  at  least  usually  found 
in  Financial  Chronicle. 

3.  Corporation    Quarterly    and     Interim    Statements. 

Usually  available  in  financial  dailies,  and  sent  direct 
to  stockholders.     Found  in  Financial  Chronicle. 

4.  Security  Circulars  issued  by  investment  houses  many 

times  give  information  nowhere  else  available — as 
well  as  the  latest  financial  reports. 

5.  Statistical  Departments  of  interested  security  houses. 

6.  Special  analyses   issued  by  security  houses  and  by 

financial  service  organizations. 

7.  Financial  periodicals,   financial  special  and   general 

newspapers.     Digest  of  news  in  t  inancial  Chronicle. 

8.  Special  semi-annual  Railway  and  Industrial  supple- 

ment of  the  Financial  Chronicle. 

[  104  ] 


9-  Periodicals — Trade.  Of  great  value  and  importance. 
Every  industry  has  one  or  more  trade  papers,  i.e., 
on  iron  and  steel,  leather,  paper,  etc.  They  con- 
tain general  and  specific  articles  of  interest  to  the 
holder  of  securities  in  the  various  industrial  lines, 
lo.     Miscellaneous  Sources  of  Information. 

a.  Indentures;  obtainable  from  security  house 
interested,  from  trustee  of  security  or  direct 
from  corporation. 

b.  Stock  Exchange  Listing  Sheets.  For  listing 
requirements  of  the  New  York  Stock  Ex- 
change see  the  Stock  Exchange  Business.  In- 
vestment Bankers'  Association,  Pages  27-30, 
Lyon,  II,  157-174;  and  Gerstenberg — Materials, 
151-161. 

c.  National  and  local  credit  agencies. 

d.  Not  the  least  important  information  source 
is  the  company  direct.  Very  often  corporation 
officials  will  freely  give  out  information  in  re- 
gard to  any  phase  of  its  activities  or  condition 
— information  which  for  some  reason  or  other — 
or  for  no  special  reason  has  not  been  made 
public. 

e.  State  publications,  e.g.,  Massachusetts,  which 
requires  submission  of  information  by  all  cor- 
porations permitted  to  engage  in  business 
within  that  commonwealth. 

For  details  in  regard  to  much  of  the  above  see  Jordan, 
395-412. 

For  books  dealing  with  special  lines  of  industry-processes, 
etc.,  consult  catalogues  of  large  public  libraries. 


[losl 


INDEX 


Note:  Certain  balance  sheet  and  balance  sheet  schedule  ac- 
counts require  little  explanation.  For  those  not  directly  indexed 
see  index  reference  to  main  headings  on  pages  38  and  39. 


Accounting  and  Accountants. 
Cost  Methods,  32;  Control, 
32,  40;  Re  Depreciation,  42; 
Lack  of  Uniformity,  35,  73, 
78-80.  See  Holding  Com- 
panies. See  Audit.  See 
Public  Accountants. 

Accounts  General,  35-41 

Accounts  Payable,  38,  59; 
Interest,  82 

Accounts  Receivable,  38,  47; 
Relation  to  Merchandise, 
89;  To  Sales,  90;  Reserves, 

38,  39.  47 

Accrued  Interest.  See  Inter- 
est. 

Administration    Expense,    76, 

79.  93 

Advances  to  Subsidiaries — A 
deferred  asset,  38,  39,  49 

Advantages  of  Large  Scale 
Enterprise,  4,  5 

Advertising.  Advantage  of 
Large  Corporations,  4;  As 
a  Deferred  Asset,  38,  39,  49 

Alliances,  30 

American  Institute  of  Account- 
ants, 35,  36,  37,  75,  76 

Amortization,  52.  Of  Bond 
Discount,  82 


Amount  of  Capitalization,  86- 
88 

Analysis  of  Balance  Sheet 
Items.     Debit,  42-49 

Analysis  of  Balance  Sheet 
Items.     Credit,  50-65 

Analysis  of  Income  Accounts 
77-86 

Analysis  of  the   Indenture,   24 

Annual  Report — Complete,  34 

Assets,  38,  39,  42-49;  Re 
Bonds,  52;  Re  Preferred 
Stocks,  55;  Undervaluing, 
63 ;  Re  Book  Value  of  Stocks, 
66-69;  Accounts  easily  jug- 
gled, 70;  New  Promotion, 
95;  Distribution,  19 

Associations — Effect,  32 

Audit.  Danger  of  Partial 
Audit,  40;  Required  in  under- 
writing contracts,  22,  33,  34; 
See  also  Public  Accountants. 

Average  Profits.  Deception  in 
Possible,  85;  When  figure 
helpful,  85 

Background  of  Industrial  Cor- 
poration Prosperity,  25-32 

Balance  Sheets,  42-65;  Re- 
quired by  contract,  34;  Lack 


[107] 


of  Uniformity,  35;  Govern- 
ment Proposal,  35-37;  Con- 
ventional with  Supporting 
Schedules,  38,  39;  Need  In- 
come Accounts,  36;  Compari- 
son different  years  in  re 
Working  Capital,  61;  Re 
Book  Value,  66-69;  Compari- 
son for  different  years  mis- 
cellaneous, 70-72;  Compar- 
ison of  different  companies, 
72;  Before  or  after  financing, 
96 

Bank  Loans,  59,  69.  Interest 
on,  82;  Conversion  into 
funded  obligations,  14,  15; 
Interest  on — See  re  unfunded 
interest  bearing  loans,  83 

Bibliography^  101-103 

Bills  Payable — See  Notes  Pay- 
able. 

Bills  Receivable — See  Notes 
Receivable. 

Blue  Sky  Laws,  98 

Bonds,  38,  50-54.  Distinction 
between  stocks  and  bonds, 
6;  Kinds,  7;  Issued  in  emer- 
gency, 13,  14;  Issued  with 
permission  of  preferred  stock- 
holders, 13-18;  When  good 
finance,  13,  14;  General 
considerations,  50,  51;  Pro- 
visions, 51,  52;  Re  Quick 
Assets,  52;  Proportion  to 
Assets,  52;  Sinking  Fund,  52; 
Callable  feature,  52;  Amor- 
tization, 52;  Reflect  value 
of  money,  57;  In  re  Book 
Value  of  stock,  66,  69; 
Interest  on,  76,  82,  83;  Is- 
suance against  earnings,  87; 
Retiring  or  replacing,  57, 
58;  Margin  of  Safety,  84, 
85;  See  Convertible  issues; 
See  Notes  (Funded  Debt) 


Bonus  Stock,  7 

Book  Value,  66-69.  Definl*- 
tion  and  method  of  finding 
for  common  and  preferred 
stocks;  Proof  and  Limitation 
of  value,  67,  68;  See  Net 
Worth. 

Brands,  38,  45,  46 

British  Companies  Act,  98 

Building  and  Equipment — See 
Plant  and  Equipment. 

By-Products.  Advantages  of 
large  corporation,  4 

Calling  of  Securities — See  Re- 
demption. 

Capital,  Liabilities  and  Sur- 
plus, 38,  50-65 

Capital,  Relation  to  Labor, 
32;  Expenses  of,  82 

Capital  Stock,  38 — See  Pre- 
ferred and  Common  Stocks. 

Capital  or  Fixed  Assets,  38, 
39,  42-46.  Re  Deferred  As- 
sets, 49;  Improper  account- 
ing, 172,  180;  In  re  Book 
Value  of  stocks,  66-69; 
Receipts  from  sale  not  Earn- 
ings, 77;  Nor  Other  Income, 
81;  Ratio  to  Net  Worth,  901 
To  Sales,  91 

Capital  Surplus,  38,  65 

Capitalization — See  Form  and 
Amount  of  Capitalization. 

Capitalization — C  hanging 
form — Advantage  and  meth- 
ods, 57,  58;  .S^r  65 

Cash  and  Cash  Resources,  38, 
39,  46,  92 

Certificates  of  Public  Account- 
ants, 40,  41 

Changing  Capitalization  Form 
— See  Capitalization. 

Charges  to  Profit  and  Loss,  76, 
83 


[108] 


Classes  of  Industrial  Securi- 
ties, 6,  7 

Common  Stock,  38;  See  Bonus, 
No  Par,  Founders  and  Man- 
agers shares;  Obligations  of 
holder  of  common  stock  to 
finance    corporation    needs, 

14,  15;  Voting  power  relation 
to     preferred     stockholders, 

15,  16,  17;  Dividend  provi- 
sions, 19;  Subscription  rights, 
19;  Conversion  of  preferred, 
21;  Relation  to  retirement  of 
preferred,  20;  May  represent 
Goodwill,  45;  Re  preferred 
dividends,  55,  57;  Few  are 
investment  issues,  56,  57; 
Influence  of  provisions  of 
senior  issues,  57;  Legality 
of  issue,  57;  Issue  of  new 
common,  58;  Rights,  58; 
Undenvriting  new  issues,  58; 
In  re  Book  Value  of  common 
and  preferred,  66,  69;  Margin 
of  safety,  84,  85;  Dividends 
after  preferred  dividends — 
See  84;  See  Average  Profits, 
85;  New  Promotions,  97 

Comparison  of  Balance  Sheets; 
Different  years,  70-72 

Competition,  27;  Resulting 
in  large  scale  enterprise,  4, 
27;  When  monopoly  possible, 
27;  See  also  5,  28,  94;  Rela- 
tions with  competing  firms, 

30. 
Consistent     Form     Necessary 

(Income  Accounts),  73 
Consolidated  Income  Accounts 

and    Balance    Sheets — See 

Holding  Companies. 
Consolidations,     45,     99;     See 

Holding  Companies. 
Contingent  Liabilities,  38,  60 
Contracts  and  Alliances,  29,  30 


Convertible  Issues,  53,  54; 
Advantage  in  preferred 
stock,  21;  when  Convertible 
bonds  issued,  53;  Advan- 
tages, 53;  How  to  find  con- 
version point,  53;  Provisions, 
54;  See  also  Bonds 

Cost  of  Production,  78 

Cost  of  Sales,  76,  78 

Cumulative  Voting,  7 

Current  Asset  Accounts,  38,  47. 
Relation  to  Current  Liabili- 
ties, 14,  89;  Sinking  Fund 
Items  not  included,  21;  De- 
ferred Assets,  49;  Re  Floating 
Debt,  61 ;  Changes  in  amount 
compared,  70,  71;  See  60 

Current  Asset  Securities — See 
Securities. 

Current  Liability  Accounts,  38, 
59,  60;  Relation  to  current 
assets,  14,  89;  Converting 
into  fixed  liability,  14;  Re 
Floating  debt,  61;  Changes 
in  amounts  compared,  70, 
71;  Relation  to  cash,  etc.,  42; 
See  60 

Deductions  from  Income — See 
Interest. 

Deferred  Assets,  38,  39,  49 

Demand  for  Product.  Changes 
and  failure  of,  26;  Fluctua- 
tion, 26;  See  3 

Depreciation — Necessity  and 
Methods,  42,  43,  83;  Secret 
Reserve,  63 ;  See  Reserves. 

Development  of  Large  Scale 
Industrial  Enterprise,  4 

Directors'  Work,  29;  Repre- 
sentation   by    underwriters, 

.34 
Discount  on  Securities,  82,  83. 

A  deferred  asset,  38,  39,  49 
Discounts,  Cash,  82 


[  109] 


Distinction     between     Stocks 

and  Bonds,  6 
Distribution  of  Assets,  19 
Diversification  of  Products,  27 
Dividends.      Provisions  of  pre- 
ferred stocks,  19;  Policy,  30- 
32;   Cash,   stock   script   and 
property    dividends,    30-32; 
Propriety  of  declaration,  30, 
35;  Relation  of  funded  debt 
provisions  and  preferred  divi- 
dends, 56;  Reserves  38,  39, 
63;    Declared,    38,    47,    59; 
Regularity,  56,  57;  Received, 
80;  Paid, '76,  83,  84.;  Margin 
of  Safety,  84,  85;  From  sub- 
sidiaries,   87;    See    Average 
Profits,  85 
Drafts  Payable,  38,  59 
Drafts  Receivable, 38,  47 

Earnings — See  76-80;  See  Net 
Profits;  "Earnings"  usually 
mean  Net  Income  or  Profit 
and  Loss  for  Period,  which 
See;  See  73 

Elasticity  in  Capital  and  Ca- 
pacity, 3 

Expenses  Accrued,  59 

Expenses.  Inconsistency  in 
charging,  74 

Factors  of  Management,  27,  32 

Factory  Cost  78,  93 

Federal  Reserve  Bank  of  New 
York.     Statement  form,  40 

Federal  Reserve  Board — See 
Federal  Trade  Commission. 

Federal  Taxes,  82 

Federal  Trade  Commission. 
Querv,  98;  Suggested  State- 
ment forms,  35,  36,  75,  76 

Financial  Control,  28,  29 

Financial  Policy,  30-32 

Financial  Structure  and  Meth- 


ods. Compared  with  rail- 
roads, 3.     See  7 

Financing.  Advantages  of 
large  corporations,  4 

Fire  Insurance,  43 

Fixed  Asset  Accounts — See 
Capital  Assets. 

Fixed  Charges.  Inconsistency 
in  accounting,  74;  See  In- 
terest; See  Fixed  Obligations. 

Fixed  Obligations.  See  Bonds; 
See  Notes  (Funded  Debt)  In 
re  Book  value,  66,  69;  In- 
come and  Charges,  88 

Floating  Debt,  61 

Foreign  Trade;  Advantages  of 
large  corporations,  4 

Form  and  Amount  of  Capitali- 
zation, 86-88;  Relation  to 
physical  value,  to  Earnings 
and  Gross  Sales. 

Founders  Shares,  6,  7 

Freight  Rates.  Influence,  25, 
26 

Funded  Obligation  s — See 
Bonds;  See  Notes  (Funded 
Debt) 

Funds — See  Sinking  Funds. 

(jambling,  33 

General  Business  Factors,  25, 
26,  27 

General  Expense,  y6,  79;  Need 
of  uniform  accounting,  79 

Good  Business  Methods,  32 

Good  Will,  38,  44,  45;  Plant 
and  equipment  item  may  be 
largely  Good  Will,  42;  Fig- 
uring Book  Value,  67;  Charg- 
ing off,  83 

Gross  Earnings — See  Gross 
Sales;    See  73 

Gross  Income — See  Total  In- 
come; See  73 

Gross  and  Net  Profit,  78-80 


[IIO] 


Gross  Profits  on  Sales  (Not 
Gross   Income),  76,  78,   79; 

S<r^  73,93 
Gross  Sales,  76-79.      Relation 
to  Cash,  etc.,  92;  In  Oper- 
ating Ratio,  93,  94 

Hidden  Assets.  Secret  Re- 
serves, 63 

Holding  Companies.  Develop- 
ment, 4;  Fraud  easy,  15,  43, 
75;  Inventories,  47;  Ac- 
counts essential,  43,  44,  47, 
75,  87,  88 

Income  Account,  73-86;  Re- 
quired by  Contract,  34; 
Government  proposal  35, 
36,  75,  76;  Called  variously, 
73;  Consistent  methods  and 
form  necessary,  73,  74;  Con- 
solidated statement,  75;  Lack 
of  standardization,  35;  Re- 
lation to  balance  sheet,  36, 
70;  Several  years  required, 
74;  See  85 

Indenture,  24 

Industrial  Mortgages,  24 

Industrial  Securities  Commit- 
tee of  the  Investment  Bank- 
ers Association  of  America. 
1919  Report  8-22 

Insurance — Fire;  Use  and  oc- 
cupancy, 43 

Insurance  Fund,  38,  48 

Insurance    Paid    in    Advance, 

^   38,  39>49    ^ 

Intangible      Assets.      To      be 

stated    separately,    42;     See 

also  Goodwill. 
Integration,  etc.,  25 
Interest.     Accrued,  37,  47,  59; 

See   59   re   Current   Liabili- 
ties; Income  Account,  82; 

Received,  80,  81;  Paid,  76, 


82,  83 ;  Margin  of  Safety,  84, 
85;  See  Average  Profits,  85; 
On  holding  company  securi- 
ties, 87;  Income  and  all  in- 
terest charges,  88;  See 
Fixed  Charges. 
Inventories,  38,  39,  46,  47. 
In  working  Capital,  60,  61; 
In  re  Floating  Debt,  61; 
Reserves,  46;  Comparison  for 
different  years,  71;  See  76  in 
connection  with  Costof  Sales, 
78;  In  Current  Assets,  89; 
See  Merchandise;  See  Raw 
Materials. 
Investment.  When  possible,  33 
Investments.  Permanent,  38, 
39,  43;  Relation  to  Surplus, 
71;  Reserves,  38,  39,  43; 
Return  from,  80,  81;  As  Cur- 
rent Asset  Securities  See 
Securities. 

Kinds  of  Securities — Stocks, 
Bonds,  Notes,  6,  7 

Labor.    Relation  to'Capital,  32 

Lack  of  Uniformity  in  Account- 
ing and  Published  Reports, 
35,  73;  5.-^78-80 

Large  Scale  Production — Ad- 
vantages, 4;  Development, 
4;  Market  for  their  securi- 
ties, 4,5 

Liabilities,  50-65  (Capital 
Stock  and  Surplus  included 
in  these  pages)  Relation  to 
Book  Value  of  stocks,  66-69 

Life  Insurance.  Importance  to 
Corporations,  28 

Limitations  of  Large  Scale 
Enterprises,  5,  27,  28 

Listing  Statements,  97 

Location.  May  or  may  not  be 
important,    26;    Matter    of 


[III] 


chance,    26;    Advantage    in 
owning  several  plants,  4;  In- 
fluence of  freight  rates,  25,  26 
Loyalty  and  Cooperation,  32 

Magnitude  of  Industrials,  3 

Maintenance,  43 

Maintenance  of  Net  Current 
Assets,  11-13,  17,  18 

Management,  27,  28,  32;  Con- 
servatism in  Accounting, 
78;  New  Promotions,  96 

Managers  Shares,  6,  7 

Manufacturing  Costs — See 

Factory  Costs. 

Margin  of  Safety.  On  Bonds 
and  Stocks,  84,  85 

Market-Development  for  In- 
dustrial Securities,  5 

Merchandise.  Ratio  to  Re- 
ceivables, 89;  To  Sales,  90 

Net  Current' .Assets — 5^^  Work- 
ing Capital. 

Net  Income.  Relation  to  sale 
of  additional  preferred,  20, 
21;  Sinking  fund  charges,  21, 
52;  Re  issue  bonds,  50,  51;  Re 
serial  obligations,  55;  Pro- 
visions of  bonds  and  notes, 
56;  Fluctuate,  56;  Earnings 
final  measure,  73;  Relation 
Earnings  to  Capitalization, 
86,  87,  88;  Relation  to  all 
interest  requirements,  88; 
New  Promotions,  95,  97;  See 
Income  Account. 

Net  Profits  (on  sales — not 
Net  Income),  76,  79,  80,  81 

Net  Profits — See  Profit  and 
Loss  for  Period,  76,  84 

Net  Quick  Assets — See  Work- 
ing Capital. 

Net  Sales,  76,  78;  Relation  to 
Receivables,        Merchandise 


and  to  Net  Worth,  90;  To 
Fixed  Assets,  91 

Net  Tangible  Assets.  Rela- 
tion to  issue  of  Preferred 
Stock,  20 

Net  Worth.  Ratio  to  Fixed  As- 
sets, Sales  and  to  Total  Debt, 
90;  See  Book  Value.     See  91 

New    Promotions.  General 

Consideration;  Information 
Tests,  95-98 

New  York  Stock  Exchange. 
Reports  suggested  like  list- 
ing statements,  34;  Reports 
required,  33;  Listing  State- 
ments, 97 

No  Par  Stock,  7;  Law  of  New 
York,  7;  Book  Value,  66-69; 
Relation  to  Inventories,  71 

Notes,  (Funded  Debt),  38; 
Kinds,  7;  Issue  with  permis- 
sion of  preferred  stockhold- 
ers, 18;  When  issued,  54; 
Refunding,  54,  55;  Reflect 
value  of  money,  57;  In  re 
Book  Value  of  stocks,  66-69; 
Interest  on,  76,  82,  83 

Notes  Payable,  38,  59;  Rela- 
tion to  Inventories,  71 

Notes  Receivable,  38,  47;  Re- 
lation to  Merchandise,  89; 
To  Sales,  90;  Reserves,  38, 
39.47 

Obsolescence-S<'^  Depreciation. 
Operating  Ratio,  93,  94 
Organization  Expense,  39,  38, 

49    ^ 
Other  Income,  76,  80,  81 
Outside   Investments — See  In- 
vestments. 

Patents,  38,  45,  46 — Charging 

off,  83;  See  g^ 
Penalties — Votmg.        For  en- 


[112] 


forcement    preferred    stock- 
holders' rights,  15-19 
Pension  Fund,  38,  48,  49 
Permanent     Investments — See 

Investments. 
Personal  Equation,  27,  28 
Physical    Value — Relation    to 

Capitalization,  86 
Plant  and  Equipment,  39,  38, 
42,  43;  New  Promotions,  96; 
Reserves,  38,  39,  42,  43 
Policy  of  Publicity,  33,  34;  See 

9 

Preferred    Stocks.         Purpose, 

8,  9,  13.  Why  attractive,  9; 
Need  of  safeguarding,  9; 
Watching  issue,  9;  Redemp- 
tion, 10,  11;  Relation  to 
Current  Assets,  11,  13,  17, 
18;  Securities  prior  to — issue 
13,  14,  18;  Obligation  of 
common  stockholders,  14; 
Relation  to  subsidiary  ac- 
tion, 15;  Necessity  for  suf- 
ficient voting  power,  15-17; 
See  22,  23;  Influence  oif  re- 
demption feature,  23;  In- 
fluence of  provisions  of  sen- 
ior issues  on  dividend,  56; 
Dividend  provisions,  18,  19; 
Subscription  rights,  19; 
Change  in  Business  restric- 
tions, 19;  Distribution  of 
assets,  19,  20;  Retirement, 
20;  R.estriction  of  sale  of 
additional  stock,  20;  Sinking 
fund  for  retirement,  21,  48; 
Conversion,  2 1 ;  Maintenance 
of  surplus,  21;  Transfer  and 
registration,  21,^  22;  Audits 
and  financial  reports,  22; 
Representation  of  under- 
writers on  board  of  directors, 

9,  22;  Directors'  meetings, 
22J  Fixing  dividend  limita- 


tion, 22,  23;  Danger  ot 
over-issue,  55;  Market 
equity,  56;  Preferred  low — 
common  high,  56;  Best  re- 
flect value  of  money.  57;  Ex- 
change of  issues,  65;  In  re 
Book  Value,  66-69;  Margin 
of  safety,  84,  85;  Dividends, 
84;  See  Average  Profits,  85; 
In  re  holding  company  is- 
sues, 87;  Place  on  balance 
sheet,  38 

Principal  Sources  of  Informa- 
tion re  Individual  Indus- 
trials, 104-105 

Profit  and  Loss  for  Period,  76, 
83,  84 

Profit  and  Loss  Credits  and 
Charges,  76,  83,  84;  Re- 
ducing Goodwill,  45 

Profit  and  Loss  Surplus — See 
Surplus  Profit  and  Loss. 

Promotions.  See  New  Promo- 
tions. 

Property  Dividend,  31 

Provisions  of  Preferred  Stocks, 
8-23;  See  Preferred  Stocks. 

Public  Accountants.  Certifi- 
cates, 40,  41, 74;  Differ  in  re- 
form of  accounts,  73,  74; 
See  Audits. 

Publicity — See  Policy  of  Pub- 
licity. 

Purchases,  76;  See  78  In  con- 
nection with  Cost  of  Sales; 
Advantage  of  large  corpora- 
tion, 4 

Quick  Assets — See  Current 
Asset  Accounts. 

Railways.         Compared  with 

Industrials,  3 

Ratio.    Gross    Profit    to  Net 

Sales,     76,     78,     79;  Net 


H13] 


Profits  to  Net  Sales,  76,  79; 
Net  Profits  to  Gross  Sales, 
76,  79,  80;  Margin  of  Safety, 
84,  85;  Special  Financial 
Standards,  89-94 

Raw  Materials,  38,  46,  47;  Re- 
lation of  Location,  35,  26; 
Management  and,  28;  Re- 
lation to  furnishers,  29,  30; 
See  46,  47;  In  re  amount 
Working  Capital  required 
62;  See  Inventories;  Re- 
serves, 38,  39,  46 

Receiverships  and  Reorgani- 
zations, 99 

Redemption  of  Securities.  Pre- 
ferred stocks,  10,  II,  20, 
23;  Bonds,  52,  54,  57,  58; 
Notes,  55 

Rents.  Received,  81;  As  De- 
ferred Assets,  38,  39,  49; 
Rents  paid  usually  included 
in  Factory  Costs  See  78 

Reorganizations,  99 

Restrictions  to  Issue  of  Securi- 
ties Senior  to  Preferred 
Stocks,  18 

Reserves,  38,  39,  62-63;  Defi- 
nition; Purposes,  How  repre- 
sented. On  plant  and  Equip- 
ment, See  citations,  42;  In- 
vestments, 43;  Treasury  Se- 
curities, 44;  Inventories,  4.6; 
Working  and  Trading  As- 
sets, 46;  Accounts  and  Notes 
Receivable,  47;  Current  As- 
set Securities,  47;  Sinking 
Fund,  48,  62;  Special  pur- 
poses, 62;  Not  funds,  62,  63; 
Secret  Reserves,  63;  Divi- 
dends, 49,  63;  Extinguish- 
ment of  Assets,  62 

Retirement  of  Preferred  Stocks 
— See  Redemption  of  Securi- 
ties. 


Rights  and  Duties  of  Corpor- 
ate Trustees,  24 

Rights  to  Subscribe  to  New 
Securities,  57,  58;  Mathe- 
matics, 58 

Sales — See  Gross  Sales;  See  Net 
Sales. 

Script  Dividends,  31 

Securities.  Current    Asset 

Securities,  38,  39,  47;  Re- 
serves, 38,  39,  47;  See  also 
Investments. 

Selling  Expenses,  76,  79,  93 

Serial  Obligations,  55 

Short  Term  Notes — See  Notes 
(Funded  Debt) 

Sinking,  Insurance  and  Other 
Special  Funds,  38,  39,  48, 
49;  Preferred  Stocks,  21; 
Use  of  Serial  Obligations  in- 
stead of  funds,  55;  Reserve 
for  Funds,  38,  39,  48,  62; 
Funds  are  not  Reserves,  62 

63. 
Special    Financial    Standards, 

89-94. 
Speculation.      When  Possible, 

33.  . 

Stability  of  Earnings.  Rela- 
tive, 3 

Standardization,  26;  Com- 
parative lack,  3;  Re  per- 
sonnel, 28;  Limits,  4 

Standard  Corporation  Form. 
Income  Account,  75,  76;  See 
Balance  Sheets. 

Stock  Dividends,  31 

Stock  Rights,  31 

Stocks.  Distinction  between 
Stocks  and  Bonds,  6;  Rights 
and  special  features,  6;  See 
Common  Stocks;  See  Pre- 
ferred Stocks. 

Subsidiaries.     Opportunity  for 


[II4I 


misleading  holding  company 
security  purchasers,  15,  43, 
75;  Accounts  necessary,  43, 
44,  47,  75,  87,  88;  Re  Inven- 
tories, 47;  Advances  to — A 
Deferred  Asset,  38,  39,  49; 
See  Investments. 

Surplus-Capital,  65 

Surplus,   Maintenance   of,   21, 

56,  57 

Surplus  Earnings.  Reducing 
Goodwill,  45;  §^^83 

Surplus  Beginning  of  Period, 
76,83,84  . 

Surplus  Ending  of  Period,  76, 
84;  Comparison  different 
years,  71;  Re  Reserves,  63; 

,     See  Surplus  Profit  and  Loss 

Surplus  (Profit  and  Loss),  38. 
Nature;  How  created;  Re- 
lation to  assets;  to  Liabili- 
ties, to  Stock,  64,  65;  Com- 
parison different  years,  71; 
Sf^  Surplus  Ending  of  Period. 

Taxes,  82;  Paid — A  deferred 
asset,   38,   39,  49;  Accrued, 

38'  59 

Total  Administration  Ex- 
penses, 76;  See  79,  93  _ 

Total  Capital.  Relation  to 
Working  Capital,  91,  92; 
To  Cash,  92 

Total  Current  Assets,  38,  47 

Total  Current  Liabilities,   38, 

59,  60 
Total   Expense   (Selling,   Gen- 
eral and  Administrative),  76, 

79,  93  ^  - 

Total    General    Expense,    76; 

See  General  Expense. 
Total  Selling  Expense,  76,  79 
Total    or   Gross    Income,    76, 

81,82 
Trademarks,  38,  45,  46 


Trading  Assets— Sr^  Working 

and  Trading  Assets. 
Trading  on  the  Equity,  50 
Transfer  and  Registration,  21 
Treasury    Securities,    38,    44; 

Reserves,  38,  39 
Trustees.     Rights  and  Duties, 

24;  Receive  audit,  34 
Trusts,  4 
Turnover,  92,  93 
Two  for  One  Rule,  89 

Underwriters.  Necessity  of 
Strong  Sponsorship,  29;  Con- 
tract Provisions — See  Pre- 
ferred Stocks,  especially  ref- 
erences to  p.  8-23 ;  Bond  Pro- 
visions, 51,  52;  In  re  new  is- 
sues, 58,  98 

Use  and  Occupancy  Insurance, 

43 

Variety  of  Industrials,  3 
Voting.  Cumulative,  7 
Voting   Power,    Common    and 

Preferred   Stockholders,   15- 

19,  22,  23 

Water — See  Goodwill. 
Working  and  Trading  Assets, 
38,  39,  46,  47;  Turnover,  92, 

93 
Working  Capital,  60-62.  Rela- 
tion of  Preferred  Stocks,  li- 
13,  17,  18;  Necessity,  li,  12; 
Amount  necessary  dependent 
upon  nature  of  business,  12; 
Methods  of  determining  in 
preferred  stock  provisions 
necessary,  12,  18;  Relation 
to  issue  of  new  preferred,  20; 
Re  bonds,  etc.,  52;  Defini- 
tion, 60;  What  included,  60; 
Requirement  in  amount,  60- 
62;  Relation  to  total  capital, 
91,92 


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